When co-signing a loan it is important think about the financial risk and obligations involved. A cosigner is a person who agrees to pay a borrower’s debt if he or she defaults on the loan. If you have a reliable credit history, co-signing for a friend or relative may reduce his or her interest rate drastically. However, should this individual default on the loan, you will be responsible for the outstanding debt. Defaulting on a loan includes failing to make payments, falsifying information on a credit application, or declaring bankruptcy. Additionally, you will be held liable for the outstanding debt if the primary borrower dies, loses his job and unable to make payments. You are taking on a risk that the lender has decided not to take. Once you have signed the documents as a co-signer, you cannot be removed unless the contract contains a co-signer release clause or the primary applicant refinances and requalifies for the loan on his own.
There are many things to consider before co-signing a loan and as a co-signor you are entitled to be informed of your obligations. A co-signers notice spells out the obligations under the loan and informs you of what is expected should the borrower default on the loan. It will ask you to guarantee the debt and provides you with notice that you will have to pay up to the full amount of the debt if the borrower does not pay. Additionally, you may be liable for late fees or collection costs. As a co-signer you are lending your good credit history to the primary borrower. The account becomes a part of your credit history and some financial institutions may factor in the cosigned loan when calculating your debt-to-income ratio.
Before co-signing, you must understand how doing so may affect your financial well-being. You should evaluate whether or not you can afford to pay the loan if the primary borrower defaults. It is important to ask the lender what you would owe in the event of a default. The lender is not obligated to give you this information but it may provide you with it if you inquire about it. Additionally, you should ask the lender to notify you in writing if the borrower misses a payment or the terms on the loan change. This provides you with a proactive approach to addressing and managing missed payments. It is always important to get copies of all important documents such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties. Read and understand these documents as they may be helpful if a dispute arises between the borrower and the lender.
At Lebedin Kofman LLP we frequently see people, including close relatives whom are affected by co-signers who have defaulted on loans, particularly student loans. It is important to understand the ramifications of what cosigning can lead to.