Co-signing a Loan: All Risk, Little Reward

Co-signers lend their names and good credit histories to the primary borrower, usually when the other borrower cannot obtain credit on his or her own. A parent may co-sign for a child who does not yet have a credit history. Other times, someone may be asked to co-sign by a friend or relative whose credit is tarnished, has negative marks in their credit history, or a low credit score.

Co-signing a loan does not mean serving as a character reference for someone else. Here’s what you should know before you co-sign a loan.

You’re Liable

When you agree to co-sign on a loan, you are liable for payment of the loan. You risk having to repay any missed payments immediately, or having to pay the full loan balance if your co-borrower defaults.

If the borrower defaults on the loan, the lender can use the same collection methods against the co-signer, such as demanding repayment of the entire loan, filing a lawsuit, and garnishing bank accounts after a judgment.

Credit score(s) may be impacted negatively by any late payments or defaults by either co-borrower. If the primary borrower dies, loses a job, goes through divorce, files bankruptcy, or otherwise fails to make payments, all responsibility for meeting the terms of the account generally transfers to the co-signer.

In some cases, the person who thought they were merely a co-borrower or guarantor was really listed in auto finance documents as the primary borrower. Be aware that if your co-borrower is primarily responsible for timely monthly payments, your credit score could suffer if he or she pays late, even if the lender did not give you a timely notification of the missed payment.

You Could Be Sued if Payments Aren’t Made

Failure to pay on the loan (or another breach of the loan agreement, like not keeping up the car insurance) means the lender can come after you for the entire balance. The co-signer often gets sued first because their credit is stronger and the bank believes they’re more likely to repay the debt.

It’s Difficult to Remove Your Name from the Loan

Once the account is opened, it’s very tough to remove a co-signer. We often hear stories of car buyers being told by the salesman to return after four to six months, at which time the dealer will supposedly remove one of the borrowers from the paperwork. This is not true, but rather a tactic to sell cars. Both the primary borrower and co-signer need to resolve the account in order to terminate the loan agreement, or obtain the lender’s express permission to remove one of two co-borrowers.

There Are Tax Consequences if the Debt is Settled or Unpaid

The lender might not want to go through the trouble of suing you, so they agree to settle a post-repo deficiency balance for less than the balance owed. This means that you could have tax liability for the difference.

For example, if you owe $10,000 and settle for $4,000, you may have to report the remaining $6,000 as “debt forgiveness income” on your tax returns and pay tax on it. Settling on the account for less than the full sum may also leave a negative mark on your credit report. You may want professional tax advice on this.

Co-signing Could Make it More Difficult for You to Get a Loan

Co-signing a loan may affect your ability to obtain loans for yourself because you have taken on the obligation to pay a friend’s loan.

Before you co-sign for someone, think about whether or not you’ll need to use your credit for your own needs. A lender may deny a credit application if there is too much credit in your name or the balances are too high relative to your income.

Seek Legal Advice

If you have co-signed an auto loan and your co-borrower has defaulted, you may be at risk of a negative listing on your credit report.  Flitter Milz is a consumer protection law firm representing people in matters against lenders, debt collectors and the credit bureaus.  Whether you or the co-borrower has fallen behind on payments or not, Contact Us for a FREE evaluation of whether your consumer rights have been violated.