By Stephen Fournier, President, Central New York Market, KeyBank
You might be asked to cosign a loan for a car you don’t drive, a college you don’t attend or a house you don’t live in, but that does not change your liability. When you agree to put your name to paper on a joint loan, you’re assuming a risk a lender isn’t willing to take on—and it can have negative consequences, both in the short and long term.
For borrowers with less than perfect credit reports or a limited credit history, getting approved for a loan can be a struggle. With the help of another creditworthy signer vouching the debt will be repaid on time, the odds of securing a credit card, car loan, mortgage or a private student loan improves dramatically. What that means is that a third party (in this case, you), in addition to the primary borrower, assumes full responsibility for ensuring the terms of the loan agreement are fulfilled.
Many people offer to cosign a loan for their child or spouse, but even then you need to think about the repercussions of that obligation. It is important for a cosigner to understand that the borrower needs a cosigner for a reason. The question becomes, are you willing and able to—and should you—take on that risk when the bank won’t?
Before agreeing to cosign a loan, consider the following obligations:
- If the borrower passes away, you assume the same responsibilities for the deceased as if you applied for the loan yourself.
- If the borrower misses even a single payment on a loan, a lender may demand full repayment of the entire outstanding balance on the loan immediately—from you.
- If the borrower defaults, additional penalties, including late fees, higher interest rates and other charges may be piled on top of the amount owed, and you are responsible for those penalties and fees.
- If the borrower defaults on the loan and it moves into the collection process, the lender may collect the debt from you. That means the lender may be able to take legal action against you.
- If the borrower habitually makes late payments, your credit will be damaged.
These are important considerations, because they have an immediate impact on your financial freedom. For example, this new debt obligation will appear on your credit report and will impact your debt-to-income ratio. Debt-to-income ratio is the percentage of your monthly income that must be applied to your repayment obligations to debtors.
As a result, your capacity for future borrowing will be diminished. The extent of how much weight this carries in the decision-making process will vary from person to person, as people have different income and debt levels, but it is something that needs to be looked at.
In addition, you are responsible for the actions—or lack of action—of the primary borrower. If your credit score takes a hit because of lack of timely payments and/or failure to make payments, it will impact your financial life and decrease your credit score.
This is important because your credit score largely dictates the interest rates you qualify for on future loans or credit card applications. Lower credit scores can increase the cost of your auto and homeowners insurance. Premiums are based, in part, on your credit history. Also, if you want a vacation home, you will pay a higher interest rate on the mortgage. The same is true for auto loans or personal loans.
If you are still willing and able to take the risk as a cosigner, be sure to get copies of all the loan documents, plus the repayment schedules. Make sure you understand your obligations under the terms of those documents. Ask the lender to notify you as quickly as possible if the borrower is late with a payment or misses a payment. Also ask the lender to calculate the amount you might owe. This way you can make the missed or late payment to prevent damage to your own credit report.
You may be able to negotiate specific terms of your obligation. For example, you may be able to limit your liability to the principal on the loan and not the late fees, court costs or attorney fees. Ask the lender to include a clause in the contract that states: “The cosigner will be responsible only for the principal balance on this loan at the time of default,” before you cosign the loan documents.
There’s a popular saying with financial planners: you can’t borrow money for retirement. The idea is that your first obligation is to secure your own financial future. Be certain you can afford to make the payment on the loan you cosign while maintaining your other financial obligations. If you cannot, do not cosign any loan document.
Because as much as you may want to help a friend, loved one or family member, you simply can’t afford to take the risk.
Stephen Fournier is president of KeyBank’s Central New York Market. He may be reached at either 315-470-5096 or [email protected].
Understanding the difference between cosigning a mortgage and joint ownership of property
People turn to cosigners when they lack either the credit or income to secure a loan on their own. Legally, a cosigner is fully responsible for repayment of the loan should the primary borrower not meet their financial obligations.
Joint ownership is not unlike a cosigned loan in that it makes it easier to qualify for the loan. In fact, one of the great benefits of joint ownership is that borrowers may qualify for much larger loans by combining incomes and credit scores. However, both parties are still legally obligated to repay the debt. Still, despite the similarities between the two, there are three major differences between joint ownership and cosigning:
1.With joint ownership, both borrowers share ownership of the property.
2. Joint owners can benefit from the property’s value
3. Both joint owners have legal rights to make decisions regarding the property.
Cosigners do not have these rights. They assume full risk for the loan without any of the benefits. With personal loans, this is not as worrisome. Most personal loans are backed by an asset. If the primary borrower defaults on the loan, the lender can seize the asset and the cosigner will often only be on the hook for the value of the loan.
Mortgages are very different, however. If the primary borrower defaults on the loan, cosigners are personally liable. It will affect their income and credit score.
A drawback of joint ownership is that it is neither easy nor simple to withdraw from. Most lenders will not allow borrowers to exit the loan agreement until the loan is fully repaid. In most cases, borrowers that wish to terminate a joint ownership partnership will have one party refinance the loan.
The party that remains in possession of the property may be required to compensate the other owner for accrued equity. In addition, without the other owner’s income and credit, the remaining owner may not be able to qualify for the refinance.
Before entering into any cosigning or joint ownership agreement, it’s important to review all of your financial and legal obligations. You should consult with your attorney and/or your trusted banker.
