October, 2004 Tax Tip
The Danger of Co-signing a Loan
This month’s Tax Tip is actually in the nature of sound financial advice. Many of my clients and others I know have co-signed loans for parents, children (especially children applying for their first credit card), significant others, or friends. By doing so they have, perhaps unknowingly, ventured out into dangerous waters.
In co-signing, you may think the primary borrower is a stable and responsible person and that your risk is relatively small when compared to helping them get some needed cash – and you may be absolutely right. Just beware of the legal ramifications.
The thing to remember is that if the lender felt it had a good chance of getting repaid from the borrower, it wouldn’t need you to co-sign. A loan is a legal contract, enforceable in court, which can make the co-signer liable for the entire remaining debt if the primary borrower defaults in whole or in part. Moreover, a default by the borrower can damage your credit record. If you are pursued by a collection agency, you can expect to be harassed constantly. It is axiomatic that collectors look immediately to the person who offers the best chance of recovering the money.
If you should get sued by the lender and have a judgment entered against you, that judgment will include interest and, very likely, the lender’s legal fees as well. It is very important that you read and understand the loan contract, which, by law, discloses all the terms of your potential liability. The lender, under the “deep pockets” theory, will more than likely come directly at you without wasting time and energy pursuing all legal rights against the primary borrower.
What if you should need to apply for a loan yourself? Even if the loan you co-signed is repaid on time each month, another lender may consider the amount of debt that you co-signed when determining if you already have too much credit.
If you do find yourself liable as a co-signer, there is no downside to try to negotiate the debt. The time value of money may very well prompt the lender to accept a reduced amount currently rather than having payments strung out over a long period of time. Make certain that you get a clean credit record in writing as part of the negotiation and then check your credit records to make sure they are clean.
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