Tip of the Week: Caution for Co-signers (5/1/00)

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	Caution for Co-signers Financial Tip of the Week by Deloitte & Touche OnLine May 1, 2000

You accept real and tangible responsibilities when you co-sign a loan.

See our archive of previous tips on your money, your taxes and your financial plan.

Just helping out. That's how many people view cosigning on a loan. Although co-signers may regard their signatures as a red-tape technicality needed to satisfy overly fastidious lenders, creditors see it for what it is: a second line of defense against default.

Under federal law, creditors are required to notify cosigners of their obligations if they opt to sign the agreement. That notice states that:

The cosigner guarantees the debt and should be prepared to pay it if the borrower does not.
A cosigner may have to pay up to the full amount of the debt if the borrower does not pay, as well as additional late fees or collection costs.
In most states, the creditor can collect this debt from the cosigner without first trying to collect from the borrower.
The creditor can sue a cosigner, garnish her wages or use any of the other collection methods that can be used against the borrower.

There are other drawbacks as well. Even if a cosigner isn't asked to repay the debt, her liability for the loan may prevent her from getting other credit because potential lenders will consider the cosigned loan as one of her obligations. What's more, if the loan is defaulted on, her credit record may be damaged.

Before writing those warnings off as scare tactics, potential cosigners should understand that they're being asked to take a risk that a professional lender wouldn't take. (If a borrower met the criteria, the lender wouldn't require a cosigner.) Studies of certain types of lenders show the track record on cosigned loans isn't promising: as many as three out of four cosigners are asked to repay loans that go into default, according to the Federal Trade Commission.

Understanding those risks, would-be cosigners who opt to go forward with the process may be able to limit their exposure by:

Asking the lender to calculate the amount of money they might owe. The lender isn't required to do this but, if asked, may be willing to negotiate the specific terms of a cosigner's obligation. For example, a cosigner may want to limit her liability to the principal on the loan, and not include late charges, court costs, or attorneys' fees. Cosigners able to negotiate such terms should make sure they are written into the loan agreement.
Asking the lender to agree, in writing, to notify them if the borrower misses a payment. That gives cosigners time to deal with the problem or make back payments without having to repay the entire amount immediately.
Making sure they obtain from the borrower copies of all important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and warranties - if they're cosigning for a purchase. Cosigners may need these documents if there's a dispute between the borrower and the seller.