When someone is denied a loan, it is usually due to lack of credit history, poor credit history, or failure to meet the required credit criteria. Whatever the reason, the denial concludes: “You pose too great a risk of defaulting”. Upon denial, the lender might suggest to the borrower, “you need a cosigner”.
Cosigning may benefit a child, family member or friend by assisting them with establishing credit history or enabling them to purchase a home or car. So long as all goes according to the terms of the loan, all is good. But the act of cosigning involves much more than performing a good deed.
Cosigning a loan creates a contractual obligation whereby the cosigner not only agrees to guarantee the other person’s debt, but to commit to paying it. Though the clear intent is that the primary borrower will pay the debt, by cosigning a loan, the obligation to pay becomes yours the same as if you were the sole borrower. If the primary borrower misses a payment or otherwise defaults under the obligation, the lender will be looking to you for payment, and has the same rights to enforce payment of the obligation against you as it does against the primary borrower. Therefore, before cosigning a loan, you should evaluate your own financial ability to pay that debt, and carefully consider the potential risks.
You are 100% liable for the obligation. Cosigning makes you jointly and severally liable, meaning the lender may come solely after you to recover payment of the obligation, without ever looking to the primary borrower. Remember, you cosigned because the lender believed the primary borrower lacked the ability to repay the loan. It is highly likely that the lender will look to the cosigner first. It is a good idea, therefore, to factor the monthly payment obligations under a cosigned loan into your own budget.
You could ruin your own credit. The debt for which you cosigned shows as a debt on your personal credit report. As such, any default by the primary borrower shows up on your credit report as a default by you.
Cosigning may adversely affect your ability to procure financing. The cosigned loan may impact both your FICO score and your debt-to-income ratio, causing you to no longer qualify under imposed credit criteria.
Your only recourse may be to sue the primary borrower and try to recover the payments you were forced to make on his or her behalf. If you were asked to cosign the obligation based upon the risk the primary borrower couldn’t pay it, it is highly likely the primary borrower won’t be able to pay you back either, even if you recover a judgment in a lawsuit
Recognizing the very real emotional pull involved when asked to cosign a loan, before agreeing to cosign the obligation, a few protective steps are recommended. First, get a copy of each document involved in the underlying transaction. Ask the lender to include a requirement to notify you of any nonpayment or other default. Request a “release clause” be added to the loan, whereby you are removed as cosigner once the primary borrower demonstrates a history of timely payments. Request a limit be placed in the debt instrument where, as cosigner, you are only obligated to pay the outstanding principal of the obligation upon default, and not any late fees, penalties, or other collection costs. Do not pledge any of your property to secure the loan. Finally, rather than putting yourself at jeopardy for having to pay off the underlying loan, if you have the means to do it, make the loan yourself and obtain collateral from the borrower as protection.
Cosigning someone else’s loan may have far greater consequences than gaining the gratitude of a family member or friend. The risks involved are real, and the potential losses impact not only your finances, but your close relationships. If you have questions concerning cosigning a loan or rental agreement, or with structuring loan or other financial obligations, at Bob Bible Law, we have the knowledge and over 35 years of experience to help you navigate these and related transactions.