If you are fortunate enough to enjoy some financial stability, then you may have friends or family members who look to you for financial assistance. While one may choose to give advice or money to someone in need, you should consider co-signing a loan for another person only with extreme caution.
It is an entirely separate issue when you buy a home or vehicle with a spouse in joint ownership (often referred to as "joint tenancy"). But when co-signing a loan with anyone else - even a child or parent - you should be aware of the serious financial ramifications that come with placing your name on the dotted line.
Co-signing a loan takes on the same significance as if the loan is for yourself. Many good Samaritans do not realize that co-signing places the full financial responsibility on them for that obligation. Regardless of who actually enjoys the use of the property and who is "supposed" to make the payments, the co-signer is on the hook for all of it.
If the primary borrower (the person on whose behalf you co-signed the loan) fails to make the payments in a timely manner or in full, the bank will pursue the person that has the better ability to pay. Unfortunately, that person probably is you.
The first response from the co-signer may be, "Why are they coming after me? What about the other person?" Most people naively assume that the lender will first exhaust all means necessary to obtain the money from the primary borrower. However, the co-signer often does not take the time to actually read the contract until the lender comes knocking. The fine print typically calls for the co-signor to allow the lender to choose whom they want to pursue. If the lending institution has a better chance of getting the money from you, then it may not waste time on a delinquent primary borrower.
Before you ever agree to co-sign a loan, it is imperative for you to understand that you signed a binding legal contract, which holds you responsible for the entire debt obligation. The contract often is a standard form that has been scrutinized time and time again, and thus will survive any challenge to its enforceability.
If the primary borrower does not pay, the outstanding debt first is reported on your own credit report. Next, the usual step is that a collection agency will seek to collect the entire debt from you, rather than the primary borrower, through harassing calls and mail.
You will find yourself the target of a lawsuit if you do not settle with the collection agency or the lender opts not to use a collection agency. If the amount owed is relatively low - usually less then $5,000 - it may be pursued by the lender through small claims court. Since you voluntarily co-signed the loan, you likely will lose the case and the court will order a judgment in the amount of the loan plus interest, legal fees and court costs. You will be required to disclose your assets and, in extreme cases, you could even lose your home.
If the person with whom you co-signed the loan makes timely payments and is on track to satisfy the debt, then everything is fine - right? Not necessarily. For example, a bank may turn you down if you apply for a loan due to the financial liability you owe as a co-signor. Because of your high debt obligations, including those as a co-signer, the bank will consider you an excessive "risk."
Caveat emptor is a well-known Latin phrase meaning, "Let the buyer beware." When it comes to co-signing a loan, the best advice may be very simple: "Run!"
Maj. Robert D. Gifford is an Army Reserve Judge Advocate with the 22nd Legal Support Organization and previously served on active duty in Bosnia, Fort Knox and Fort Sill. Maj. Gifford serves as an Assistant U.S. Attorney for the District of Nevada. The views expressed in this article do not necessarily reflect those of the Department of Justice or Department of Defense.
(c) 2006, InCharge(r) Institute of America, Inc. All rights reserved.