Cosigning a Loan
In today’s economy, some people have a hard time obtaining credit. In particular, young people, who may have limited credit and employment history, sometimes find it difficult to obtain a loan from a financial institution. Since credit is so important to many people who are trying to purchase a home or a car for the first time, or to finance a college education, relatives such as parents and grandparents often want to help family members get their start.
In some cases, financial institutions suggest that potential borrowers find someone to “cosign” the loan, in order to qualify the borrower for a line of credit. Banks require another person to cosign a loan because they do not have confidence that the individual borrower can repay it. There are, however, significant legal implications for a cosigner. The Attorney General’s Office provides the following information to people who are considering a cosigned loan.
What happens when you cosign:
When you cosign a loan, you become legally obligated to repay the loan if the borrower doesn’t pay it, or somehow defaults on the agreement. It is as if you took the loan out yourself, but are counting on your relative or friend to make each and every payment as spelled out by the terms of the loan. It is important to remember that, even if the borrower has the best intentions to meet his or her obligations under the loan, unpredictable things can happen that can derail these plans, such as a loss of employment, unexpected illness, etc. Most cosigners believe that the borrower will be able to repay the loan on his/her own at the outset, yet the Federal Trade Commission reports that three out of four cosigners end up repaying the full amount of the loan..
Risks of cosigning a loan--what you need to know:
- If the borrower does not pay, you may be forced to repay the whole amount of the loan. With most cosigned loans, the lender need not go after the borrower first, but can request payment from the cosigner any time there is a missed payment.
- If the borrower defaults, you may be responsible for late charges, penalties, legal fees and could possibly end up paying more than the original amount of the loan.
- The lender may take legal action against you, pursue you through debt collection agencies, or sell the debt to a “debt buyer” to try to collect the money that is owed on the loan if the borrower does not pay or defaults on his/her obligation.
- Your credit can be impaired. If the borrower defaults, the lender will probably report this to the credit bureaus, which could lower your credit score. Even if the borrower only experiences temporary financial troubles and misses just a payment or two, then cures the loan and comes current, this payment history can affect the cosigner’s credit, making it harder to refinance his/her own mortgage, or obtain other lines of credit.
- Even if the borrower doesn’t default, cosigning a loan could still affect your credit. Lenders will view the borrower’s loan as your own and may believe that you owe more debt than you really do. This could affect your ability to get a loan of your own.
“Carolyn” cosigns a car loan for her son, “Dave,” so that he’ll have transportation to and from his first job out of school. Dave’s employer downsizes its workforce due to the bad economy after a few short months of employment, and Dave is let go. Unable to pay the car loan, Dave defaults on the loan agreement, and the finance company repossesses and sells the car. Unfortunately, the amount of the sale is much less than the amount of the loan, leaving a “deficiency.” The finance company then begins collecting the balance of the loan from Dave’s mom, Carolyn. Carolyn is stuck paying for the remainder of Dave’s car loan even though he no longer has a car, and she is approaching retirement.
If you still want to cosign:
Consider the alternatives:
- Can you make a gift instead of cosigning?
- Can you help the borrower secure a loan?
- Can you make a private loan?
- Read the fine print in the terms and conditions of the loan. Make sure you understand what you are signing up for. You may want to have an attorney or a financial advisor review the terms to make sure you fully understand your obligations under the loan.
- Before you pledge property, such as your car, to secure the loan, make sure you understand the consequences. You could end up losing these items if the borrower defaults.
- Ask the lender to calculate the amount of money you might owe. The lender isn’t required to do this but may do so if asked.
Obtain access to the borrower’s information:
- Ask the lender to agree in writing to notify you if the borrower misses a payment. This will give you time to deal with the problem or make back payments without having to repay the entire amount immediately.
- If you are cosigning for a purchase, make sure you get copies of all important papers, such as the loan contract, the Truth in Lending Disclosure Statement, and warranties. You may need these documents if there is a dispute between the borrower and the lender. You may have to get copies from the borrower.
- Get duplicate statements sent to your home. If you are able to do this, you won’t have to rely on the lender to notify you about missed payments.
- Get online access to the account. This will give you the most immediate and up-to-date information and allow you to keep track of the payments real time.
Cosigning a loan is a generous act with potentially serious consequences. You generally should only cosign a loan if you have the ability and willingness to pay off the loan in the event of default.
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