Money - Personal Finance
By: - at June 28, 2013

Cosigning: Should You or Not?

Who is a Cosigner?
Signing a documentA cosigner is a party in an agreement between a creditor and a borrower where the cosigner undertakes to pay the loan, interest, and associated costs if the borrower fails to pay. When the lender finds the risk of default by a loan applicant to be very high, he can only approve the loan if a third party undertakes to pay, in case of default. Therefore, instead of rejecting the application, the creditor requests the loan applicant find a cosigner. The cosigner should have a high enough credit score to get the loan approved without considering the credit score of the applicant. Furthermore, the cosigner should undertake to repay the loan as if he is the one who applied for and received it. Usually, the borrower and the cosigner have a social relationship such as a parent and child or a couple. This article describes the financial risks of cosigning and precautions to take if you decide to do it.

When is a Cosigner is required?
Creditors usually require cosigners for the following two categories of applicants.

1. Applicants with poor credit records have formed financial habits that make them easily default and could easily repeat them.

2. Applicants who have no credit history and no experience in managing a loan repayment can easily default. Usually, applicants in this category are trying to get loan for first time.

Obligations of a Cosigner
The cosigner is obliged to pay the entire loan and interest if the borrower defaults. Another financial obligation of the cosigner is to pay additional fees associated with the loan: collection costs and late fees. Therefore, the cosigner is as responsible for paying back the loan as the borrower. In fact, a cosigner is a co-borrower. The lender can use the same loan recovery methods used on the borrower to recover the loan from the cosigner, in case of default. These methods include garnishing wages, suing, and selling property.

Financial Risks of Cosigning
Cosigning has the following four serious financial risks.

1.Money finances You can lose a lot of money and pledged property in paying the loan, if the borrower fails to pay. Even if the applicant is a responsible person, the unexpected could happen to make the borrower unable to pay the loan. For instance, the borrower can lose employment if the employer loses business and decides to retrench some staff. Furthermore, if the borrower goes bankrupt, the cosigner has to pay the loan.

2. The lender can sue you in court if the borrower defaults. Court cases are costly, stressful, and time consuming.

3. The transactions on the loan become part of the cosigner’s credit record and can negatively affect its rating if the borrower defaults in payment. Late payment or default will earn the cosigner negative credit scores.

4. The cosigned loan increases the debt-to-income ratio of the cosigner and makes it difficult for him to get approval for their own loan or credit. Furthermore, lenders consider cosigned loans before approving a loan application and may not approve the next loan if the cosigned loan is in default.

How to Reduce Risks of Cosigning
Despite the risks, you may find it necessary to cosign a loan. For instance, you may do it to help a close relative or loved one repair their bad credit history. Another case is if the applicant is your child in first job with no credit history. You may consider it your responsibility to help the applicant get the first loan and start to develop a credit history. You should take the following nine precautions to reduce the risks.

1. Set aside enough money to settle the loan in case of default. People with low credit ratings are irresponsible of their finances and are very likely to be more careless if somebody else is obliged to pay for them. Studies show that borrowers default in three-quarters of consigned loans.

Financial Planning2. Insist that the lender omits the clause that obligates the cosigner to pay all associated costs. The omission exempts you from paying costs such as attorneys' fees and court costs.

3. The contract should have a clause that obliges the lender to inform you as soon as the borrower fails to submit an installment. It is easier to pay one missed installment than many accrued ones. Furthermore, you can persuade the borrower to resume making payments before the situation gets worse

4. Insist that the applicant pledges some property as security. For instance, the property can be the one the applicant intends to buy with the loan. If the borrower fails to pay in payment, the lender can seize and sell the property to recover the loan. The cosigner is not responsible for paying the loan after the lender uses the property settle it.

5. Insist that the lender deletes the acceleration clause from the contract. This clause empowers the lender to recover the balance on the full loan and fees from the cosigner immediately once the borrower misses to pay one installment.

6. Insist that the lender deletes the clause in the standard loan agreement form that makes you an automatic cosigner for subsequent loans the same lender gives to the borrower. If you sign the agreement with the clause, the lender does not have to consult or ask you to sign a new agreement for a subsequent loan to the borrower.

financial documents7. Carefully review all documents.

8. Get copies of important documents. You can use them when a dispute arises between the lender and the borrower. Important documents include warranties, Truth-in-Lending Disclosure Statement, and the loan contract.

9. Consult a legal adviser to review the documents and suggest any other cosigning rights before you sign.

Conclusion
You should avoid cosigning because the financial risks associated with it are very serious. Besides, the transaction can ruin your relationship with the borrower in case of default. Furthermore, you may develop health problems from the stress caused by the transaction. Rather than go into cosigning, it is better to persuade the loan applicant to withdraw the application and help in avoiding unnecessary expenses and improving financial management. This is a safer way to help somebody to repair a bad credit history.


 

 

 

 

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