Co-signing liability can get complicated, so educate yourself

Occasionally, you, or someone you know, may be asked to co-sign a financial obligation for the purchase of a car or a house or the rental of an apartment or commercial space. Sometimes the request is simply to co-sign a personal loan, so that the borrower has access to the necessary funds. Most often, this request is made by family and friends. But what are the risks? Is there a better alternative?

Although the term “co-signer” does not have a universal meaning and application because the exact meaning is derived from the signed contract, it generally means that the person co-signing provides additional security to the person or entity offering the credit or financing (“creditor”) and assumes the same responsibility for payment as the original debtor.

Equal responsibility

Take note of this meaning and that it generally does not mean that the co-signer is alternately responsible. It means equal responsibility. In addition, in general, the creditor can pursue payment of either of the co-signers for all sums due to the creditor in the event of default.

It can get even more complicated for the co-signer because sometimes the contract specifies that all notices for all signatories can be sent to a single party – call it the principal debtor. This is probably the person you agreed to help, not the co-signer.

To sum it all up so far, you could offer to co-sign, never receive a notice of deficiency, and then be liable for the full amount owed to the creditor to include penalties and interest on a debt in the event that the principal debtor would not make payments in a timely manner. Your credit could also suffer. Some of the notice provisions can be changed in the contract to ensure that the co-signer receives effective notice, but the payment obligation still stands.

Assets concerned

But it’s getting worse. The problem of co-signing is further compounded when dealing with assets for which the creditor has security (aka “collateral”) to back up repayment. This most often happens with houses or cars.

To grant security for the collateral, the co-signer often needs to be on title to the asset to show ownership (and that ownership then enables the co-signer to grant the security for the obligee). As a result, in many cosigner situations, the cosigner unwittingly also owns an asset.

Take a mortgage as an example. You help a child get a home loan by putting your name on the title and co-signing the mortgage. As noted above, you therefore retain a risk of liability for payment of the obligation. But, more than that, you now own an asset that could expose you to additional liability.

For example, suppose the house that was purchased had an attractive nuisance (see my previous column, “How to Protect Against Attractive Nuisances to Avoid Liability”). Also, suppose a child was injured on this property due to the attractive nuisance. You may have inadvertently exposed yourself and your property to the child’s lawsuit against the owners of the property that contained the attractive nuisance. It can also be complicated to later try to remove your name from the title – even after all financial obligations have been paid.

Reduction measures

Is there a better way?

To some extent, the liability of the co-signer can be mitigated in several ways.

First, the co-signer can choose not to be on title to an asset (if possible) to reduce the potential liability associated with that asset.

Alternatively, the co-signer can request that the property be placed in a limited liability company or other entity that can help protect an owner’s personal assets from the entity’s debts (which could help with the liability issue). of the premises but does not relieve you of the responsibility for the repayment of the loan).

But the smarter way is to try to avoid co-signing altogether if you can find another solution.

Often a co-signer is needed because the principal debtor does not have the funds or income to obtain the loan on their own.

Perhaps you can then help the principal debtor to independently qualify for the loan. This is the preferred solution.

For example, maybe you could offer $10,000 to help the principal debtor pay a higher down payment on a house so they can qualify for a better loan.

On the one hand, this may seem more generous than simple co-signing, but on the other hand, it imposes a strict limit on the extent of the obligation. In other words, you are no longer responsible for the entire mortgage in the event of a problem. You are no longer potentially liable for premises liability issues.

Instead, you are only responsible for the amount you gave – your $10,000. The other option is to lend the money yourself. Of course, there are many downsides to lending money to family or friends (see my previous column, “Follow these rules when lending money to family, friends.”) but it could be better than being responsible for a debt to a third party over which you have little control.

Beau Ruff, licensed attorney, is Director of Planning at Cornerstone Wealth Strategies, an independent investment management and financial planning firm in Kennewick.