I received an email last week from a lady who was in dire straits. She had co-signed a student loan for a relative and was recently notified that she was due to start making a monthly payment of nearly $800 (since the student had defaulted). This is money that she just doesn’t have. While she thought she was doing a good deed helping a young man get financed to go to college, she is now committed to nearly $10,000 a year in debt payments for the foreseeable future.
“A person without understanding shakes hands in an oath and signs jointly for a friend.” (Proverbs 17:18)
I regularly get emails from people wondering whether or not they should co-sign to help a loved one or friend. This can be for a student loan, car loan, mortgage, or even a credit card. While working in the mortgage business several years ago, it became apparent how little people understood about the financial and legal ramifications of joint signing.
On numerous occasions I had to inform a client that their loan had been declined due to a loan they had co-signed. In some cases, the loan was not paid on time and had destroyed his credit. In other cases, adding another monthly obligation made your debts represent too high a percentage of your income for approval. Everyone seemed to be in a state of disbelief saying, “but it’s not really my debt…” Unfortunately, lenders don’t see it that way.
1. You can end up bankrupt
When you co-sign a loan, you are 100% responsible for payment along with the primary borrower. If loan payments are not made, the lender will attempt to collect from you and may ultimately obtain a judgment in court. Once a judgment is obtained against you, you may be forced to sell assets such as your home, car, and other personal belongings, as well as garnish your wages from your job. As a result, you may have no choice but to file for bankruptcy.
2. Debt cannot be discharged in bankruptcy
In the case of a student loan, most of the time you cannot discharge this type of debt in bankruptcy. What’s worse than going bankrupt? Being insolvent without being able to obtain bankruptcy relief. A debt that cannot be discharged in bankruptcy can potentially follow you for the rest of your life! Even for debts that are deemed eligible for discharge in bankruptcy, you should be able to qualify to file a Chapter 7 discharge bankruptcy. Under the new bankruptcy laws, you must meet a number of guidelines in order for the court to allow you to discharge any debt in bankruptcy. Otherwise, you may end up in a court-ordered Chapter 13 bankruptcy (payment plan) for five years or more.
3. It can seriously damage your credit score
Even if the debt is paid on time, it can still lower your score. Adding another loan to your credit file may cause you to have too many open credit accounts to maintain a high credit score. Of course, if a single payment is made late, this will do even more damage to your overall score.
4. Your debt ratio will take a hit
When you apply for a loan, a lender will consider the percentage that your monthly debts represent of your monthly income. Income-to-debt ratios are used in almost all forms of lending. Mortgage companies, auto finance companies, and even credit card issuers consider them just as important as your credit score.
5. Your interest rates may increase
We have been inundated with emails from people seeing substantial rate increases being charged on their credit cards. For almost whatever reason, credit card companies seem to quickly raise rates for even their best customers these days. If a loan you co-signed for even has one late payment, you may see substantial increases in the rate you pay on any variable-rate debt you have.
The key lesson here is to never co-sign unless you are fully prepared to pay the debt yourself. This is what you may end up having to do in the end.