Imagine you’re out car shopping and you finally find what you think is a reasonably priced set of wheels … and then when the dealer pulls your credit, the monthly payment that seemed so affordable is no longer available to you. You might be offered a subprime car loan at 10% or even 20% interest, and you really need a car, but the interest rate just seems crazy-high. It feels even worse knowing most other other buyers are paying less than 5% (the current industry average is 4.4%, according to Edmunds).
Even though you can get financing, your poor credit may be costing you thousands of dollars. (You can see what poor credit can cost you over a lifetime with this calculator.) But you may be able to get a better deal if you get a co-signer. It’s not terribly common, and only certain lenders offer that option, says Edmunds senior analyst Ivan Drury.
How much can you save? If you financed $28,480 (the current industry average) at 4.4%, you’d pay $3,693 in interest (and payments would be $480 a month). If you financed at 10%, you would pay $8,802 in interest (with a $556 monthly payment), a difference of more than $4,000 over 67 months, the current average term. If the co-signer had excellent credit, you’d likely save more than that. Pentagon Federal Credit Union, which you can join for a small donation to a military charity, was recently advertising 2.49% for loan terms between 60 and 72 months. So it’s more than just a few dollars a month difference in payments.
Other Ways to Cut the Cost
Auto finance expert Matt Briggs said interest rates at some of the “buy here, pay here” dealers run all the way up to 20%. But even with the potential savings, co-signing may not be the best way to make the loan affordable. A couple of other factors make the high-interest loan even more expensive.
First is the term of the loan. Although loans now typically run more than five years, experts suggest terms of no longer than five years for new cars and no more than three for used. So, for the same payment in a shorter term, you are likely looking at a much more modest car. (On the other hand, compressing the time will reduce the difference in what you’ll pay in interest over the life of the loan.)
Briggs said the punitive rates are most often offered to people who are young and who have poor credit or no credit. But he sees co-signing for a lower rate as “a little of a double-edged sword.” He said that even though the co-signer is added to the loan, “I don’t know how much it helps your credit.” He sees it as potentially becoming an endless cycle, but conceded it may make sense when the person co-signing is a spouse with higher credit.
Before You Co-Sign
Drury said he thinks this kind of scenario is more likely to be parents helping children. “Or,” he said, “it could be a very, very good friend, but you had better hope they have a solid six years of employment lined up.”
And, for the co-signer, co-signing for a lower rate carries the very same risks as co-signing in general, which is to say it can be a very dangerous move for the co-signer, with all the benefits going to the primary borrower. As a co-signer, not only are you on the hook for the entire loan, but you may not be warned that the primary borrower isn’t making the payments on time. I know someone who co-signed for an employee so they would have a way to get to work and then got stuck with the repo on his credit!
Still, if you are a parent, it is going to be very difficult to watch someone you love spend thousands more than they would have to if you would just sign your name (and put yourself on the hook for the full amount of the loan). If you want to help, you can do so a couple of other ways.
One is to encourage your adult child to look into loans through local banks or credit unions. It’s possible he or she can get financing there; it can’t hurt to ask. And if no one, anywhere except the “everybody rides” dealer is willing to lend money, it’s time to learn about building credit.
One risk-free way is to simply give the adult child money to make a bigger down payment. That, too, will reduce his or her payments because less of the car’s equity will need to be financed, and it will not put your credit or finances at risk. (However, you should not consider giving money if you cannot easily afford it.)
Offer advice, rather than a signature. Although the average car loan is for more than $28,000, that’s an awfully big loan for someone who has little experience repaying debt or has poor credit. And reliable cars can be had for less. Perhaps driving a less-expensive car is an option while building credit. Understanding the difference between wants and needs — and learning to say “no” or “not yet” to oneself is likely to be more valuable to your kid than that shiny car left sitting on the lot. Just not today.
In the meantime, the borrower can learn how to work toward a stronger credit standing. Making those car payments on time every month, over time, will help them build credit. Tracking their credit scores as they go can help them keep tabs on their progress. They can see their credit scores for free on Credit.com, where they can also get an overview of their credit, and a plan to help them build it over time.
More on Auto Loans:
- Are There Car Loans for People With Bad Credit?
- What to Do If You Can’t Make Your Car Payments
- Top 5 Worst Car Buying Mistakes