Your son or daughter graduated from high school and is heading off to college. They are in need of a car, and you feel this is an opportunity for them to establish credit in their name. The bank however, will only approve the loan if you agree to be a cosigner. Should you do it?
When asked to cosign a loan understanding liability and potential consequences is essential. It is difficult to say no to family members in need, but risking ruined credit or liability for a large bill should have you carefully considering this decision and if this is a wise financial move.
Individuals with no credit or new credit may have difficulty getting a loan. In these cases, banks often request a cosigner as a condition of approval. Whether you are cosigning or guaranteeing a loan, you are promising the lender you will pay the loan back if the first party fails to make on-time payments. Loan cosigners typically do not anticipate ever being required to make any payments.
Cosigning a loan introduces a high degree of liability and a low degree of benefit for the cosigner. The lender can legally hold you liable for 100% of the balance, including interest, late fees and collection costs. Lenders like cosigners because it gives the m the ability to approve applicants with inadequate credit, margin payment history, or income that is unreliable. A cosigner with excellent credit reduces bank risk of non-payment, allowing them to approve an application that would otherwise be declined.
Risk of Cosigned Debt
Repayment history reported to the credit files of both parties. Payment histories are typically recorded for a seven-years. Any late payments could impact the credit of both parties. Applicants with new or poor credit may be less concerned with on-time payments than those stronger credit.
Primary account holder receives all notifications, not cosigner. Unless steps are taken to gain access to account information, billing, and late notices are only sent to the primary account holder, leaving the cosigner vulnerable to damaged credit without knowing how the account is being handled
Collect first from cosigner. When payments become late, lenders may choose to collect from the cosigner as the first line of defense. Having a higher credit score and potentially more assets, makes you more of a target when it comes to collection. If you pay the loan, it would then be your responsibility to collect the debt from the primary account holder, or take the loss. Responsible borrowers are more likely to catch up loans and prevent default.
Repossession of secured loans. When cosigned loans are secured by an asset, even voluntarily returning the asset will result in a repossession recorded on your credit. A repossession will stay on your credit file for seven years and you could wind up paying any balance due after the sale.
Impacts “debt to income”. A new loan on your credit will be calculated in your debt to income, if you need to apply for credit while the loan is outstanding. This could affect your ability to qualify for additional credit, which will be impacted by both the loan balance and the monthly payment.
Irreversible act. Once the loan is signed a bank will be unwilling to release you unless the account can be successfully refinanced in the account holder’s name or the loan is paid off. A lot can happen while the loan is outstanding. Many cosigners seek to get out of a loan if it becomes delinquent, however banks will not remove your name because they are more likely to be able to collect from you than the primary account holder.
Authorized User Accounts Versus a Cosigned Loan
A cosigned loan creates a legal responsibility for repayment of debt for both parties on the loan. Each party is 100% responsible for the repayment of the debt.
An authorized user has access to credit and a credit card in their name, yet have no legal responsibility for making payments.
Authorized user accounts can be an effective way to help children or spouses with limited credit history establish credit.
Credit Counseling or Debt Negotiation
When the primary account holder enrolls cosigned debt in either credit counseling or debt negotiation, collection efforts can still be made with the cosigner. Negotiated debt has the ability to reduce or eliminate legal responsibility for the primary account holder. Any remaining balance, or reduced settlement, can still result in the cosigner being pursued for the difference. Defaulted debt is reported on both credit files.
At the point when bankruptcy is filed for a primary account holder, collection efforts must cease with regard to the primary account holder. However, collection companies may still contact the cosigner in an effort to collect the debt. Final discharges in bankruptcy only offers relief for the primary account holder, and does not impact the liability of the cosigner. The primary account owner may choose to keep the account, as opposed to having it discharged. They also have the option to continuing making payments on the account. Cosigners are also given the option of maintaining the account rather than putting it through bankruptcy.
Debt Liability in Community Property States
Common law states and community property states operate with different rules when it comes to assets and debts. Titles and date of ownership are central to liability and dividing assets and debt in common law states. The marital relationship is the central factor when settlements are made in community property states.
Death and divorce are the most common occurrences where these laws come into play. The states of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are considered community property states. In Alaska, it is possible to create a community property agreement in writing, giving you the rights and settlement arrangements that would be found in a traditional community property state.
Community property rules dictate that all assets and debts acquired during the course of a marriage is for the benefit and responsibility of both parties. There are typically only three exceptions that will be considered.
- The property was owned prior to marriage
- A gift was given to one spouse.
- Inheritance received by one spouse.
When individual assets or debts are combined with joint assets, these exceptions may no longer apply. As a rule, both debts and assets are understood to be co-owned even if they are only held in one name.
When a divorce occurs in a community property state, debts and assets are divided 50/50. When a death occurs the surviving spouse is typically responsible for all debts, and inherits all assets, regardless of the titling on accounts.
When asked to cosign a loan, consider your liabilities and the potential consequences if things don’t go as planned. Credit can be damaged and you could wind up making the payments. Due to the heavy liability, financial advisors typically advise against cosigned debt.
If you are struggling with debt that you have assumed through a co-signer relationship, contact one of the specialists at Timberline Financial Today for a FREE debt analysis. They will review your current situation and provide a customized plan to help you reduce your debt.