Co-signing a loan

Over the years I have met many people who have co-signed loans, or signed as a guarantor for someone only to regret it later. Many of these people have told me they would never have done it if they had really known what they were getting into. When you sign to help someone else obtain a loan you are putting yourself at financial risk. If they do not make the payments, you will have to, and your credit rating will be affected as well.

Co-signing will also reduce your ability to borrow money for your own needs – at least until the co-signed loan is repaid. So before you sign on the dotted line - ask yourself can you really afford to pay for this loan – if not then do NOT sign the loan agreement.

Guaranteeing a loan

First of all, co-signing a loan is not the same thing as guaranteeing a loan, even though many people think it is. One of the main differences is when a loan is guaranteed, the lender must demand payment first from the debtor before going after the guarantor. But a person who co-signs a loan is just as responsible for the loan as is the original debtor - the one who borrowed the money in the first place. That means that the lender can demand payment from the co-signer before, or instead of, approaching the debtor.

Falling behind – missed payments

What if your daughter recently bought a car and you co-signed her loan from your bank? As long as she makes all her payments on time, everything is fine. But, what if she finds she can't manage the payments and without telling you, she gets behind. You could then find your bank account being set off for the debt before you know it and to make things worse, most loan agreements contain what's called an acceleration clause. This clause says that your bank may demand immediate repayment of the whole loan - not just the arrears - if any condition of the agreement has been violated. So one missed payment could mean the entire amount of the loan suddenly has to be repaid. Can you afford this – consider carefully before you sign.

Security – seize or sue – not always both

If the loan originally was granted for the purchase of a car, the car would most likely be pledged as security for the loan, by means of a security agreement, and can be used in addition to a co-signer’s signature. Then, if payments fall into arrears, the bank would have the option of seizing the car. However, depending on the province you live in, if the lender did that, you as the co-signer would be off the hook, because if the car is seized the lender loses the right to sue, even if the car is worth less than the amount outstanding on the loan.

Of course if the co-signer put up security for the loan, the lender can choose to seize those goods rather than go after the original borrower. A person who guarantees a loan for another, can also end up taking full responsibility for the debt. The difference is that, the lender has to first demand payment from the borrower before going after the guarantor.

How much did you co-sign for and for how long?

One major pitfall that's contained in the standard guarantee form that's used by many lenders is a clause that makes the guarantor responsible not only for the loan that is being currently arranged, but also for any future amounts the debtor may borrow from the same lender. This applies even though the guarantor may have no knowledge of any future loans. Therefore I strongly advise you to put a maximum limit on the amount of money you are prepared to guarantee and a time limit. Do this in writing – give the lender a copy or better yet have it written right into the loan agreements, before you sign them.

Business arrangement

Sometimes it can be necessary or appropriate to co-sign, or guarantee a loan for someone. However, even if it is a family member who needs help remember this is a business arrangement – so treat it that way, put everything in writing and advise the lender you want to be kept informed each month of the status of the loan. Contact the lender periodically to get written updates on the loan status. Take nothing for granted.

Why does the lender require your signature?

If a lender will not grant credit to someone there usually is a good reason. Before you agree to put your name on someone else's debt, look at the situation carefully. Ask questions:

  • Why does the lender require a second signature?
  • Is there really a credit risk?
  • What will be the consequences if you don't sign?
  • And, most important, can you afford to pay off the loan if the borrower defaults?

If you do decide to go ahead and co-sign or guarantee a loan, ask the lender, in writing, to keep you informed of all activity on the account. By doing this you may be able to identify a problem in its early stages, and correct it before it affects your credit rating. You should also insist on receiving a copy of every document you sign. If you must co-sign for someone, be sure you have all the facts clearly explained to you prior to signing, or you could end up regretting what you have just done.