Cosigning A Loan? Know the Risks!

CONSUMER ALERT

BILL SCHUETTE

ATTORNEY GENERAL

The Attorney General provides Consumer Alerts to inform the public of unfair, misleading, or deceptive business practices, and to provide information and guidance on other issues of concern.  Consumer Alerts are not legal advice, legal authority, or a binding legal opinion from the Department of Attorney General.

Cosigning a loan? 

Know the risks!

When you cosign a loan for someone, you are helping that person obtain a loan that he or she would not be able to get on their own.  You are also taking a risk that a professional lender will not take.  The lender would not be asking for a cosigner if the borrower met the lender's criteria for making a loan. 

Before taking this risk and cosigning a loan, be sure you understand the potential consequences:

• You could be liable for the total loan obligation.

• There is no requirement that the lender first attempt collection against the borrower before collecting from you.  In fact, studies of certain types of lenders show that - for cosigned loans that go into default - as many as three out of four cosigners are asked to repay the loan. 

• Your credit rating could be damaged. 

• If the lender sues and wins, your wages and property may be subject to garnishment or other collection actions.

• Even if the loan you cosigned is not in default, your liability for the obligation may prevent you from securing other credit. 

• If the borrower declares bankruptcy and his debt is discharged by the Bankruptcy Court, you will still be responsible unless you also file for bankruptcy.

FEDERAL AND STATE LAW PROTECTIONS FOR COSIGNERS

Because of the risks involved with cosigning a loan, Federal law requires lenders to give potential cosigners the following notice:
 

You are being asked to guarantee this debt.  Think carefully before you do.  If the borrower doesn't pay the debt, you will have to.  Be sure you can afford to pay if you have to, and that you want to accept this responsibility.
 

You may have to pay up to the full amount of the debt if the borrower does not pay.  You may also have to pay late fees or collection costs, which in­crease this amount.
 

The creditor can collect this debt from you without first trying to collect from the borrower.  The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc.  If this debt is ever in default, that fact may become a part of your credit record.
 

This notice is not the contract that makes you liable for the debt.
 

Further, Michigan law offers protection to a cosigner in the event the borrower defaults on the loan.  Under State law, before the lender may report adverse information about the cosigner to a credit reporting agency or take any collection action against the cosigner, the lender must do both of the following:

(a)   Send the cosigner, by first class mail, a notice advising that the primary borrower has become delinquent or defaulted on the obligation and the cosigner is responsible for payment of the obligation.

(b)   Allow the cosigner at least 30 days from the date that the notice was sent to respond to the notice by either paying the amount due, or making other acceptable payment arrangements with the lender.  If payment or payment arrangements are made, the lender may not report adverse information about the cosigner to a credit reporting agency. 

PRECAUTIONS TO TAKE BEFORE YOU COSIGN

Despite the risks, there may be times you decide to cosign. Here are a few things to consider before you cosign:

• Be sure you can afford to pay the loan. If you are asked to pay and cannot, you could be sued or your credit rating could be damaged. 

• Consider that, even if you are not asked to repay the debt, your liability for this loan may keep you from getting other credit you may want. 

• Before you pledge property to secure the loan, make sure you understand the consequences.  If the borrower defaults, you could lose the property. 

• Ask the lender to calculate the specific amount of money you might owe. The lender does not have to do this, but some will if asked.   

• Negotiate the specific terms of your obligation.  For example, you might want to have your liability limited to paying the principal balance on the loan, but not late charges, court costs, or attorney's fees.  In this case, ask the lender to include a statement in the contract like this: "The cosigner will be responsible only for the principal balance on this loan at the time of default."    

• Ask the lender to agree, in writing, to notify you if the borrower misses a pay­ment.  This way, you will have time to deal with the problem or make back payments without having to repay the whole amount immediately.     

• Make sure you get copies of all important papers, such as the loan contract, the Truth-in-Lending Disclosure Statement, and any warranties if you are cosigning for a purchase.  You may need these if there is a dispute between the borrower and the lender.  Because the lender is not required to give you these papers, you may have to get copies from the borrower.

Consumers may contact the Attorney General's Consumer Protection Division at:

Consumer Protection Division
P.O. Box 30213
Lansing, MI 48909

517-373-1140

Fax: 517-241-3771

Toll free: 877-765-8388

www.michigan.gov/ag (on-line complaint form)