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You co-signed, they defaulted: It's your loan, now


Dear Steve,
I co-signed on an auto loan for my daughter who now has missed three payments on that loan. The bank is calling me, and I have no idea where my daughter or the car is. How can I handle this with the bank and also help to clear my credit report, which is showing delinquency in payments? -- Kathy

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Dear Kathy,
As a co-signer on your daughter's auto loan, you are responsible for payment if your daughter defaults. Because you do not know how to contact your daughter, the short answer to your question is that unfortunately, you will need to make the past due payments to the bank. You will also need to continue making payments until your daughter is able to do so.

Depending on the bank, smaller may be better in this case, go in person to make the payment. Ask to speak to the manager, explain the situation, tell them you are pleased to pay the three payments (you can cross your fingers if you need to!) and ask them to not report the account as past due. They may not have sent any data to the credit bureaus yet and they might still be able to change it if they did.

Co-signing a loan for someone, particularly a relative, is generally a bad idea. There is usually a good reason why the lender won't lend the money to the person in question. They know it, but often you don't. Co-signing is something that many people are asked to do and that many end up doing to help out a friend or relative. The co-signer feels good about the situation because he or she has helped that friend or relative buy a new car, house or boat or receive her first credit card. What the co-signer often fails to do is consider the consequences to her or his own finances -- and the relationship.

Kathy, clearly, you are a generous, caring person, so please review the list below of things to consider before co-signing a loan, to better prepare yourself for the next time you are asked to co-sign. Then read on for things to do once the loan is signed and the co-signer does not fulfill his or her part of the deal.

What exactly does it mean when you co-sign a loan?

  • You are guaranteeing that you will make the loan payment if the borrower defaults.
  • You are saying you are willing and able to pay the full amount of the loan and any late fees or collection costs.
  • In some states, the creditor can collect the debt from you without first attempting to collect from the borrower.
  • The loan and any activity associated with it is listed on your credit report.

Before you sign:

  • Can you afford the monthly payment? Do not co-sign a loan if the prospect of making the payment would put you in a financial bind. No one has a crystal ball to predict the future. Plan as if the loan were your own.
  • Will the outstanding loan prevent you from obtaining credit for yourself? Even though the co-signed loan is not for you, potential creditors consider the amount of the loan as your credit obligation. Therefore, you may have to postpone a mortgage or other large loan until the co-signed loan is paid off.
  • How well do you know the borrower? Keep in mind that an institution that specializes in lending has turned this person down for a loan. Don't help a bad credit risk at the expense of your own credit.
  • Will you have to secure the loan with your own property? The property used as collateral could be lost if the borrower defaults. If it is an heirloom or otherwise important to you, think twice or perhaps three times.
  • How important is my relationship with this person? A financial relationship as a co-signer could ruin a personal relationship, especially if the borrower cannot pay. Trying to preserve a personal relationship with a person who has a credit problem, by helping them get more credit is a fool's errand. Help them live within their means or correct their credit, but lending them your credit and personal financial guarantee is a recipe for disaster.

If the borrower skips out:

  • Make payments to the creditor to protect your own credit. If the account is delinquent, try to bring the account current as quickly as possible.
  • Submit a 100-word statement to the three major credit bureaus explaining why the loan is delinquent.
  • Communicate with the borrower and determine if he or she can begin to make payments again.
  • Keep close track of the loan payments if the borrower does begin to make payments again.

Love moves us all to do things we would not ordinarily do. I hope you can work things out with your daughter.

The Debt Adviser, Steve Bucci, is the president of Money Management International Financial Education Foundation. Visit MMI for additional debt advice or click here to ask a debt question.

-- Posted: April 4, 2003




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