Cosigning on a loan or other debt is making an agreement to become jointly liable for the debt. Cosigning on behalf of another person usually means that you are using your credit to convince the lender that the loan will be paid back. You are usually equally liable on the loan with the person on whose behalf you have cosigned. The lender will ordinarily send the payment book or other documentation of a payment due to the person who actually gets the money or property being paid for with the loan. If that person does not pay, the lender will collect from the cosigner. If he borrower defaults, the cosigner is usually liable for payment of the entire unpaid balance of the loan in full (along with any additional collection costs), not just one half of the balance.
In general, cosigning a loan is different from guaranteeing a loan. A cosigner is equally liable with other cosigners on a loan and may be pursued for the unpaid balance due whenever there is a default in a payment.
In the case of a guarantee on the other hand, a lender normally only pursues a guarantor after there has been a serious default and the lender has made some collection efforts against the borrower first, possibly even obtaining a judgment. A guarantee is a different type of contract from cosigning and has some important, different, requirements to be valid.
A borrower may require a cosigner if he (or she) is taking out a loan for the first time, if the loan amount is high and he is earning less than what is required to qualify, if the borrower has irregular or seasonal income or if he has bad credit scores.
In case of a small business or a corporation with a single shareholder, a bank or other lender giving a substantial loan will usually ask the shareholder (and sometimes a spouse) to cosign for the loan. This can also happen in a corporation or other business with multiple shareholders, where the bank may ask all, or at least the major shareholders, (or any shareholder with assets) to cosign for personal liability for a loan. Cosigning a business loan makes the cosigner equally liable with the business on the loan. From the lender’s perspective, this helps increase the accountability of the business owner for repayment of the loan, particularly if the shareholder (or the cosigning spouse) has assets and the business doesn’t. It helps protect the bank against a company with few assets declaring bankruptcy without having to repay the loan. Cosigning a loan can place the personal assets of the shareholder or other business owner, along with those of their spouse, at risk of being sold or otherwise liquidated to pay business debt. To an extent, cosigning for business debt defeats the purpose of a corporation or other business entity in protecting owners or shareholders from their creditors.
It is tempting to help someone out in getting a loan to buy a house or a car, getting an education or helping a business. People will be grateful to you for the help in getting the loan. Attorneys will, however, generally discourage you from cosigning on a loan if it can be avoided. Cosigning for that first auto loan for your daughter or son or a close friend will make you a hero, but you must then protect yourself by making sure that auto insurance is always paid on time. You must also hope that daughter or son or other party you cosigned for keeps their job and otherwise shows financial responsibility by making the payments in a timely manner.
Virtually any bankruptcy attorney would advice you not to become a cosigner in most situations. Your degree of involvement as a cosigner depends on the lender. Some might call you up at the first instance payments are not received for a couple of days, others might not call until the things get quite bad. If the borrower refuses to pay back the loan, you either have to repay the loan yourself or let your credit scores plunge and face collection action which can even include court action and having your paycheck garnished or your assets taken.
There is another drawback in becoming a cosigner. By cosigning you extend your credit to enable another person to get a loan. When you apply for a loan, a lender will look at you as being a higher financial risk because you have an additional extension of your credit. You might not be able to get a loan for yourself when you need it.
If a person you care for wants you to become a cosigner, try other options like making a small gift to increase the borrower’s down payment. A lender may extend credit to a borrower with a larger down payment and not make them cosign. If cosigning is the only option available, remember a few points:
– Read the terms and conditions of the loan when you are cosigning.
– Get a copy of the contract from the lender after you have signed.
– Get the loan statements mailed to you every month and/or ask for an online access to the loan account.
– Make arrangements with the borrower that they get a refinance and repay the loan at the earliest date possible.
– Consider the possibility of having your name placed on any collateral paid for with the loan and keep the collateral insured, possibly even through the monthly loan payments if this can be done for a reasonable cost.
Cosigning is a generous act. However, there is no shortage of stories of ungrateful kids, ex-spouses, siblings and friends who have brought down trouble on their cosigners. Cosign a loan only if you trust the person fully, can afford to pay if that person loses their job or defaults for any other reason, or if that is the only option available. Even then exercise caution.