The Danger in Cosigning a Loan

by : Doug Pare

To an extent, you may be extending a helping hand to somebody you know to secure a loan by cosigning it. Mostly such situations arise when the person applying for the loan is a minor or if the borrower has some credit risk against his name so that they cannot secure a loan on their own. But, on a practical point of view, cosigning a loan has its own risks associated with it. It can lead to tricky situations if the borrower fails to make the payments regularly. And when the cosigner realizes the trouble, it would be too late.

In the event of a borrower defaulting on the payments, according to the federal law, it is the cosigner who has to bear the responsibility of the debt and hence he/she is liable to compensate for the missed or missing terms. And in terms of the payment, the cosigner may have to pay what the entire amount borrower has failed to pay, and the final amount might also include late fees, collection cost and accrued interest if there is any. According to the law of some states, it empowers the creditors to directly approach the cosigner for the payment defaulted by the borrower even without summoning him even once. The law permits them to resort to any collection methods, which can be used on the borrower normally, on the cosigner such as garnishing the wage or suing the person concerned. Either way, it will eventually damage the credit of the cosigner.

In retrospect, if to study the plight of cosigners whose parties have defaulted with the payments, it is evident that in four out of five times it is the cosigner who eventually had to bear the brunt of the unfinished payments. Hence, it is always better to be aware of the possible potholes one could find in the way if the borrower fails to make the return payments promptly. Let us consider few points that one must consider before putting pen to paper, even if the borrower is your child or a close relative.

As a first step, make sure that you have enough backup to payback the debt should a need arise. Here we assume a worse case scenario, but it is better to close all chinks in the armor.

Ask the lender how much you owe him in the event of an extreme situation. It would be prudent to negotiate specific terms of your responsibility such as limiting the liability to just the principal, and to fees like exclude court costs, late charges, and attorneys' fees. Remember, you - as a cosigner of a loan - have all the right to ask the lender to give in writing, that he/she will notify you in case the borrower makes a default in the payments. Such a move will help you with more time for damage control.

Take care to preserve all documents relating to your cosigner-ship. That may prove useful in an emergency situation. Also, learn about your rights as a cosigner as laid down by the law of the state. Mind you, ignorance is the biggest foe to mankind. We tend to make mistakes out of ignorance.