Why you Should or Should Not be a Cosigner
It’s that time of year when college kids are heading back to school. Many of them are moving into a new apartment. Obtaining a lease for an apartment or a car, or purchasing a vehicle entails a significant financial commitment. Many times the borrower or potential tenant has little or no credit history. In these cases, the lender or landlord will often require a parent or other person to cosign the note or lease as a condition of acceptance.
There are two capacities in which a person will generally co-sign a note, either as a maker or as a guarantor. In either case, your potential exposure is basically the same. A similar type of contract called a surety agreement will also be addressed here. A suretyship or contract of surety occurs when a third person or entity takes on liability for the borrower’s debt as part of the original debt instrument. In the event that the debtor defaults, the surety is immediately liable for the debt. If you cosign a car loan or lease, this is probably the capacity under which you are signing.
A guaranty agreement is different from a suretyship in that it is a collateral agreement. This might take the form of a personal guaranty. The guarantor is not a party to the original agreement and has no right to sue under the original agreement. A guarantor becomes liable for the borrower’s debt only after the borrower defaults. A guarantor or surety will be obligated to repay the debt even when the principal debtor declares bankruptcy. Moreover, should the bankruptcy court modify the debtor’s obligations to the lender, the guarantor’s obligations remain the same.
Lenders and landlords want co-signers because they believe that there is a reasonable likelihood that the principal borrower or tenant will default on their obligations. This is especially true when the borrower or tenant has a poor or an insufficient credit history. When you cosign a note or a lease, you are not just giving your word that the borrower or tenant will abide by its terms, you are agreeing that you will pay yourself if they do not. When you are a co-signer, you are agreeing to take a risk that the lender or landlord has chosen not to.
If a borrower is applying for credit from a finance company, it could mean that he has been rejected by traditional lenders. This should be a red flag for you. Don’t be a cosigner if you feel uncomfortable with the possibility of being solely responsible for the outstanding obligation. According to the Federal Trade Commission, seventy-five percent of finance company loans end up being paid by the cosigner.
When there are multiple parties to pursue for a loan, the lender is going to go after the easiest one first. If you have a job, own a home or have a bank account, these are prime targets for a garnishment and the lender will likely go after these before chasing around the original debtor who may have a lot less to offer.
If you decide to be a guarantor or a surety, you should carefully read the contract to ensure you know what you are agreeing to. In some cases you could be on the hook for significant interest, penalties and attorney’s fees in addition to the principal debt. A judgment against you could result in a wage garnishment, a lien on your home, a levy on your bank account and even the seizure of personal assets such as vehicles and equipment.
With secured notes, the lender will have the right to repossess the item. While this is some consolation, often the value of the collateral is less than what is owed on the note. This is especially true when dealing with automobiles which depreciate quickly. After an automobile is repossessed, re-sold and the proceeds applied to the outstanding obligation, the original borrower is often left owing a substantial amount of money. Not only could you be subject to a significant judgment, but you will do substantial damage to your credit in the process.
There are some times when it makes sense to be a cosigner. One instance is when you are trying to help your child establish credit. There are some steps that you can take to minimize your risks. First, ask the lender to notify you in the event that the borrower is late or misses a payment so that you can take care of the obligation before it gets out of control. Second, inform the lender that your obligation will be limited to the principal debt, and not include interest, late fees, and attorney’s fees. Finally, negotiate an out – that is, if your child has made a certain number of payments without default, that your obligation is terminated. Whatever agreement you reach with the lender, make sure that it is reduced to writing, that the lender and you sign it, and that you get a copy. A verbal promise may be difficult or impossible to enforce in court, and in most cases will not even be binding to begin with.
A loan and how it is paid will appear on both the primary borrower and the cosigner’s credit reports. Any late payment will damage the credit of both borrowers.
This article is intended to provide general information only and is not legal advice. If you have specific questions about your situation, you should seek the advice of an attorney. Call us today to schedule a consultation.