Why You Should Avoid Co-Signing a Loan
It is always a difficult situation when a friend or family member asks you to co-sign a loan. Co-signing a loan means paying a borrower’s debt if he or she defaults on the loan. The reason for the loan may seem quite reasonable, such as to attend school, to purchase a car, to gain independence by purchasing a home or to start a business. The reason you are asked is because the asker believes you have savings (and a better credit score and credit history than the person wanting the loan.)
You may feel obliged to help a friend or family member to obtain financing or you may want to help him or her to build credit. You should not let your emotions guide your decision. This is especially true if you are pressured about this or made to feel like you ‘owe’ it to the requester. It is important to look into the risks of co-signing and asking if he or she consulted with a bank and to learn more about the situation.
There are several reasons you should not co-sign a loan, outlined in the paragraphs below.
The Bank Seeks More Assurance than the Primary Borrower
If a bank, which is in the business of lending money, is not willing to lend a person the funds or requires a co-signer (co-borrower), then there must be a good reason; the bank does not believe that the person will be able to repay the loan and/or want extra assurance. This is also true on other loans like car purchases. Banks have much experience projecting the likelihood of a loan going into default and they conduct extensive research on statistical probabilities to determine the criteria and circumstances under which they will offer a loan. If the bank won’t provide a loan, expect that there is a good chance that the individual will not pay the loan that is denied without you. Default risk is a high probability and a significant problem in our society across different socio-economic levels, whether due to an unforeseeable inability to pay or due to lack of responsibility.
You Must Keep Track of the Bills and Payments
When you agree to co-sign for a loan, you do not automatically receive a copy of the monthly statement and have no way to track whether the payments were made other than by checking online (if you can get access) or by calling customer service. If you wait to review whether payments are being made until a collection agency calls, then your credit report will already be damaged.
You are Responsible for the Entire Liability
When you co-sign a loan you are literally the co-borrower and are responsible for the entire loan balance, including interest and any other fees that may arise. You could be potentially responsible for legal costs incurred by the lender to collect the outstanding balance owing. Before co-signing anything, ask yourself: Am I prepared to pay this whole debt off today? Or Would I just give this money to the borrower as a gift? If not, do NOT co-sign the loan.
Your Credit Rating is put at Risk
When you co-sign a loan your debt-to-income ratio increases and you put your entire financial situation on the line. Amounts you owe affect your credit score, such that the more debt you have the lower your credit score. If you have too much debt relative to your income, then your own application for a new loan or credit could be denied; about 30 percent of your FICO credit score accounts for how much credit you have already used and 10 percent accounts for how often you seek credit.
If the loan is paid late or not paid, your credit will be damaged further; about 35 percent of your credit score depends on responsibility and timeliness of payments. If a repossession of the other party’s purchase occurs, repossession will be displayed on your credit report too.
You May Need to Put Money Aside to Pay the Loan
Because there is a significant risk that the co-signer could default, you should put aside payments (e.g., of at least twelve months) into a savings account to keep in the event you need to pay the loan due to non-payment of the primary borrower. This means you will have less money available for yourself and you will need to keep funds accessible until the loan is repaid in full.
Your Rights are Limited
You cannot remove yourself as co-signer/co-borrower. Once you accept the responsibility to co-sign a loan, you are tied to the debt for as long as it is owed unless a release clause in the loan agreement provides otherwise.
A lender will not automatically contact you when a loan payment is paid late or not paid. If you are aware that payments are not being made, you have no ability to force the sale of the asset you co-signed for (e.g., car or house) as you do not own it. You are simply on hook for the debt.
The lender will not contact you before repossessing an asset or ask if you wish to purchase it. The lender will simply contact you to pay the difference between the debt and the below-wholesale repossession price they received, known as a deficit.
The Lender Can Sue You If the Payments are Not Made
A lender could come after you legally to pay the loan if you co-signed for it. A lender might sue you before the person you co-signed for because your credit is higher and therefore you are more likely to pay. A lender is not obliged to sue the other party before pursuing you.
You May Need to Sue the Primary Co-signer
If you get sued by the lender, you might have no choice, financially, but to bring the other responsible party (for whom you co-signed) into the lawsuit in order to get him or her to help with the monthly payment. This could be quite difficult if you cannot locate the other party or he or she is not working. Even if you win, you might not be able to get the primary co-signer to pay his or her obligation. You may need to hire a lawyer to help you collect the debt which will also increase your costs.
No Protective Measures
Lenders have insurance and other protective measures to limit their risks, including through extensive legal language in their loan contracts, which you don’t similarly have. You also don’t get to have collateral for the loan or the ability to repossess an asset and sell it to recover loaned funds. Getting your family member or friend to sign a promissory note is simply that, a promise to pay. Even if you later decide to go to small claims court to recover an unpaid loan or damage to credit, there is no guarantee that you will successfully collect the money owed.
The Loan Can Destroy a Friendship or Family Relationship
Monitoring payments for a loan can cause tremendous stress, especially if you have to call your friend or family member to ask why payments were not made. If the other party stops paying altogether, it can cause extreme conflict in your relationship and your own financial load.
You May Be Enabling a Person to Get into Debt or Take on More Debt
If you co-sign the loan, the person may be temporarily happy but may later have some regret in taking out the loan and he or she could end up having buyer’s remorse. If you don’t co-sign the loan, the person requesting the loan may put more thought into the matter, rethink it and create an alternative way to enhance his/her own financial situation to improve.
When to Contact a Bankruptcy Trustee in Edmonton
You are best to contact a bankruptcy trustee BEFORE co-signing. The consultation is FREE. Get expert advice quickly. At the same time you can then assure your requester that you have sought financial advice on this matter before making your decision (and are not alone in the decision). There is no good financial reason to co-sign a loan, but it is your decision. If you have already co-signed for a loan, you may be feeling some regrets but if you are still in the process of considering being a co-borrower, really think twice about co-signing that loan.
A bankruptcy trustee at A.C. Waring & Associates in Edmonton can help you deal with a co-signing default and your debt overload because of it. We provide debt help in the Edmonton area and Northern Alberta, including debt consolidation, financial restructuring, credit counselling, consumer proposals and bankruptcy proceedings. Call us in at 780-424-9944 or 1-800-463-3328.