Co Signing Loans Responsibility Assignment

The advice for cosigning a loan for a family member or friend is always virtually the same: Don't do it, and if you do, understand the consequences if something goes wrong.

But what if you ignore the advice and cosign, and the loan goes south for reasons beyond your control?

Although there is no database that tracks cosigned loans, anecdotal evidence and some data suggest cosigning is common – and it isn't always parents cosigning for children. In 2010, LeaseTrader.com, a national car leasing marketplace, reported a 29 percent increase over the previous two years in the number of parents asking their kids to cosign a car loan for them.

So what happens if you've tried to help a loved one, and that loved one can't keep up with the payments, so you're stuck paying for his or her credit cards, student loans, car or even house? Or perhaps you also can't pay, and you're watching your once-sparkling credit score crash and burn. Maybe the situation is even worse, and your family member or friend won't make the payments. What then? Are you stuck paying off the loan, or is there an exit plan?

The answer to both parts of the question is yes. Neither situation is pretty, but if your goal is to simply extract yourself from the predicament, here are some of your options.

Stall. Just how bad is this situation? If the original person doing the borrowing is willing to pay but can't right now, and you can't even temporarily take over the payments, you can always see if the lender will put a forbearance in place. This is essentially a temporary reprieve, usually for just a month or two, although with student loans, the time can be more generous, like six to 12 months. If you just need to buy some time, you may be able to.

Take out a loan to pay off the cosigned loan. As Richard Lee, a partner at the Los Angeles-based law firm Salisian Lee LLP, suggests, you or the borrower might find a third party, "like a debt-consolidation company or some other hard-money private lender, willing to take a risk by financing the early payoff of the original loan and taking an assignment of the principal debt."

The idea is that this third party pays off the debt, and the borrower – that is, your adult daughter or relative – is responsible for the new loan, Lee says. The odds of finding a lender who will do this are not good, but if you can swing it, your problems are over.

But your family member's problems are just beginning. He or she almost certainly has shoddy credit at this point, so the new loan will likely have a much more severe interest rate or terms. You might not be able to stomach that if you think this loan has the potential to ruin your relative's life. But everyone's financial situation is different, and this might be the perfect solution for you, and even for both of you.

Refinance. "This can sometimes be a long shot, but if the loan is through a bank that the signer or cosigner have worked with in the past, and there is history, it's possible the bank will be willing to renegotiate the terms of the loan," says Sue Katz, a community outreach coordinator with American Consumer Credit Counseling, a nonprofit based in Auburndale, Mass.

The problem is that lenders are most willing to refinance if the borrower and cosigner have good to excellent credit, and if the borrower has been having trouble making payments, that's probably no longer the case.

Another point to consider: Even if you and your borrower can refinance for a smaller monthly payment, the borrower may wind up paying more in interest if the loan is stretched further into the future, from, say, a three-year loan into a five-year loan. But what if the borrower still can't make the payments, even though they're smaller, and you end up taking over? In the long run, you're worse off because you'll pay much more in interest.

"Once your co-signer has reverted to late payments or defaulted altogether, it has been my experience that your best way out is not to try and renegotiate the loan to smaller payments," says Kristen Fricks-Roman, a financial adviser with the global wealth management division of Morgan Stanley in Atlanta.

She adds: "We often think the reason our loved ones aren't keeping up with their responsibilities is because they can't when the truth is they won't."

Refinance on your own. As in, don't have your borrower on board. This is, of course, a big step. You're taking full ownership of the loan now.

But if the goal is to simply get lower monthly payments with a smaller interest rate so your borrower can pay off the loan more easily, sending payments to you instead of the lender, this might be a reasonable plan.

Still, there is plenty to consider. You thought the consequences of cosigning were bad? If you refinance the entire debt on your own – that house your son was buying, the credit card debt your nephew collected – that's all yours now. And while the plan may be to have your co-signer pay you back, you could be left high and dry with the debt.

On the other hand, as the sole owner, you'd have leverage to insist your tenant continue to make mortgage payments, which would be smaller and more manageable, or that he or she pay rent to you. The same goes for a car. It's yours to drive anytime you want, and you could even take possession of the vehicle and sell it, if you don't mind frosty family get-togethers.

Recoup your money another way. If this debt you've cosigned for has truly drained your bank account and you want to make your money back, Fricks-Roman has some interesting ideas.

First, with any luck, your relative or friend wants to pay you back and feels terrible about this loan gone amok. If that's the case, you could ask the borrower to direct-deposit part of his or her paycheck into your account, Fricks-Roman suggests.

But if that isn't going to happen, Fricks-Roman says less-appealing options include redoing your will and excluding the loan amount from it. That won't work for everyone, especially if you're worried about your own retirement, let alone leaving something behind in a will.

She also suggests removing your relative from your "gift list" until you've recouped your financial outlay. Of course, due to the size of some loans, that might be a lifetime.

Bankruptcy. It can be virtually impossible to get student loans discharged in a bankruptcy, but with other cosigned loans, this might be the way you'll have to go.

But there's another, more hopeful thought, Lee points out. "Even if the parents don't want to declare bankruptcy for any of the chapters – Chapter 7, Chapter 11, Chapter 13 – it can be a useful negotiation threat to gain leverage with the original lender in renegotiating a forbearance or other type of grace period to allow the child to get back on his feet, get a job and re-start making payments," Lee says.

In other words, even if you have no intention of ever going bankrupt, your borrower's lender doesn't need to know. Of course, even mentioning the word "bankruptcy" to a lender could have unforeseen consequences – the worst way to instill confidence in a financial institution is to tell them you may have to declare bankruptcy. But that's the thing about extracting yourself from a cosigned loan. There are no good solutions to pick, only the least revolting one.

Tags: credit, personal finance, debt


Geoff Williams has been a contributor to U.S. News since 2013. He has been a freelance journalist for over 20 years, specializing in personal finance and small business issues. His work has appeared in numerous publications, including CNNMoney.com, The Washington Post, Entrepreneur Magazine, Entertainment Weekly and Forbes.com. He is also the author of several books, including "Washed Away," about the great flood of 1913, "C.C. Pyle's Amazing Foot Race," about the infamous Bunion Derby of 1928 and "Living Well with Bad Credit." You can follow him on Twitter @geoffw.

This “ 11 Things to Consider Before Co-Signing a Loan ” post provides overview about what people (i.e. people who intend to co-sign) need to be aware of before putting their signatures on the loan applications.

Co-signing a loan for someone can be a generous thing to do but can be dangerous at the same time. I’ve heard so many horrible stories about people helping out others through co-signing with horrible results. It is true that doing this can be daunting especially when you hear these kinds of stories.

There are many situations that co-signing a loan for somebody is necessary especially when that person is just starting to build up credit. If you are a parent, you may find the need to do it for your child. Of course, family may be exceptions to the unwritten rule of “Don’t co-sign for others”.

What is co-signing?

Co-signing is simply signing a legal document jointly with another person. According to the Federal Trade Commission (FTC), when you co-sign a loan, the lender must spell out what your obligations are as a co-signer. FTC also states that when you co-sign a loan, you are asked to guarantee the debt. In addition, you may have to pay the full amount if the borrower does not pay.

Why is there a need to co-sign?

One of the main reasons that co-signers is needed is that the main borrower is unable to obtain a loan under his own name. This can happen when the borrower doesn’t have good credit or simply has not built up credit yet.

Things to Consider Before Co-Signing a Loan

A lot of people would say to never co-sign for anybody. The risks associated with doing this can or will far outweigh the benefits and this statement is true. But before you say yes or no to co-signing, it is best to understand and get a better picture of what the risks and repercussions are when co-signing goes wrong.

1. Purpose

One of the things to consider Before co-signing a loan is to know that purpose of the loan is.

Before even entertaining the idea of helping somebody through co-signing a loan, always ask where the loan is going to be used. It is a basic question that many co-signers fail to ask.

If the borrower is going to use the money to pay for another debt, you may need to re-consider if you really need to co-sign a loan with that borrower. Ask yourself how the person’s going to pay the loan. Is he or she going to ask for another loan to pay the current loan?

However, if the person is in need of immediate loan because of some emergency situations like medical issues, then, you may consider co-signing for that person if you know he or she is responsible in handling and managing finances especially loans.

There’s always a purpose for getting a loan. It is within your right to know it especially if you’re the one co-signing the loan application.

2. Borrower

When you co-sign for somebody, you are considered the borrower in the eyes of the credit bureaus. This means that the loan will reflect on your credit history as well as that of the main borrower. If the borrower fails to pay on time and/or defaults, then, you will see that your credit score will take a hit.

You need to take this fact into consideration when somebody is asking for your help. Once you co-sign for somebody, you will need to make sure that payment is made on time. If you’re too busy to mind other people, then, it’s in your best interest to decline such request.

You don’t want to baby sit the main borrower but you may have to especially when your credit is on the line.

3. Relationship

You may have helped one of your family members or friends get a loan by co-signing. This is a good way to build and enhance relationship. Having said this, you still need to take precautionary measures to maintain a good relationship with the person you care, in this case, the borrower.

A lot of people fail to pay their loans and they go into default. Just because the person who you helped is close to you, doesn’t mean that situations like this won’t happen to him or her. If ever the borrower fails to pay the loan and defaults, then, your relationship may be at stake. I hope it doesn’t happen to you but there’s always a possibility that your relationship will get sour if he or she does end up in this situation.

You will need to sit down and talk about the repercussions of not being able to fulfill the terms of the loans. As much as you want to believe that your relationship will not be affected when something wrong happens, the truth is that relationship can be negatively affected when loans don’t get paid. It’s just a reality of life and a lot of relationships have been broken because situations like this happen.

 

4. Responsibility

You may ask who will be responsible when the main borrower fails to pay the loan. The answer is simply you. As co-signer, you are responsible to pay the loan back along with the late fees and accrued interest. In many cases or states, you have equal footing on the loan and so, you are as responsible as the main borrower when it comes to paying back the loan.

According to the FTC, studies have shown that 3 of 4 or 75% of those co-signed loans that end up on default end up having to be paid by the co-signer.

You may find that this is not the worst situation. If the borrower has been in default for a couple of months, you will find your unpaid loan in the hands of the collection agencies. When this situation happens, you are looking at paying additional fees on top of late fees and accrued interest.

This scenario is not the scenario that you want to be in but this is one of the realities that can or will happen to you if the borrower fails to pay the loan and, then, defaults.

I’m not trying to discourage or frighten you. The idea of co-signing is guaranteeing the creditor that you will pay the loan back in case the main borrower fails to pay.

5. Happiness

Of course, if you are co-signing a loan for someone who can’t get a loan and the loan is approved, the person will surely be happy. But happiness can be short lived. The person may not care about paying the loan and can go into default.

When co-signing with other people, always make sure to check the credit background of the people you will likely help. You’ll never know how well or bad their credit scores are until you check them.

You will also need to understand their spending habits. You may also need to sit down with the borrower and ask how he or she is serious with paying back the loan. Of course, he or she may say yes but it’s always best to be straightforward. After all, your credit score is only one of the many things at stake in co-signing.

Of course, you don’t just pull up their credit histories without informing them. Let them know that it’s your requirement before you consider helping them. If they refused to do so, then, it may be best for you to distance yourself from helping them. Sometimes, precaution is better that solution.


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6. Property

If you, as the co-signer, secures a loan with your own property such as your house, you are running the risk of losing your property. This may happen if the borrowers fails to pay the loan back.

When co-signing a secured loan, always make sure that you understand the risk of losing your property. Better yet, you may not even want to co-sign a secured loan as this may hit you hard twice (one with your credit score and the other with losing your property).

7. Tax Consequences

If the main borrower fails to pay the loan and goes into default, you may find yourself looking for ways to solve the problem before it gets worse. You or the lender may find that settlement is better. This settlement is almost always below the outstanding balance. You think your dilemma is over? Hardly.

You could face tax liability for the difference between the outstanding balance and the settled amount. For example, if you still owe $15,000 and the lender settled for $8,000, then, you may have to report the $7,000 in your tax return as debt forgiveness income. Remember this amount may be considered income and you will need to report it and pay taxes on it.

The lender may provide you a 1099-C also known as Cancellation of Debt.

8. Future Loans

Ever wonder why a lot of people can’t seem to get another house loan, car loan, among others? This may be because they already have the same type of loans in their credit file.

If you co-signed somebody for a car loan, you may find that you may not be able to get another credit of the same type. If you do get a loan, you may find that you will have to pay more interest just because your credit utilization ratio is higher.

If you are looking at getting a loan for yourself in foreseeable future, you may be better off if you stay away from co-signing another person. Always take time and think things through before co-signing for somebody.

A misstep can make a big difference on your ability to secure a loan of your own in the future.

9. Garnishment

Yes, even the wages or assets you own can be garnished if ever you and/or the main borrower default(s) from the loan.

According to Tuition.io, for private student loans, there must be a court judgment before your wages or assets can be garnished. On the other hand, for the federal loans, lenders can go ahead with garnishment if you defaulted.

You are not only affecting your credit score but you are also affecting your wages or the assets you own.

10. Behavior

While co-signing a loan may seem to have more risks than benefits, there are benefits of co-signing a loan. Co-signing is one of the ways you can do to can help another person build his or her credit. If you happen to co-sign a loan with your child, then, you are helping your child build his or her credit.

Young people especially those who want to start building their credit may not necessarily be able to start doing it because they don’t have credit in the first place. Sounds crazy, right? Not really. This is the irony when it comes to building up a credit. You need to have a credit to build a credit. One of the best ways to do it is through co-signing a loan with that person.

This doesn’t mean that you need to take out a huge amount of loan so you can help your son or daughter build up his or her credit. You can always take a $500 loan and start from there.

Since you are the parent, it is best to orient your child about responsible borrowing. This is one of your ways to teach your child on how to manage and handle responsibilities.

11. Exit Strategy

When you co-sign for somebody, it is best to have an exit strategy prior to signing on the signature line(s) on the loan application. Always make sure that you understand what you and the main borrower will get into and plot an exit strategy to remove yourself from loan equation. Not a lot of lenders may allow you to get out of the loan. If that’s the case, you will be stuck until the loan has been paid off.

It doesn’t hurt to ask the lender if it allows the co-signer to be removed from the loan at a certain point.

 

The decision of co-signing an application should not be taken lightly. The decision you make can and will affect you positively or negatively. It’s always a great idea to make necessary steps to ensure that you safeguard not only your credit scores but also those important things in your life such assets and relationships that can be negatively affected.


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