Why You Should Never, Ever Cosign a Loan for Anyone
I mentioned in my last post that cosigning loans is risky. How risky? According to the FTC, depending on the type of the loan, as many as three out of four primary borrowers default on their obligations, leaving the cosigner to pay. This is, after all, why they need a cosigner: they’re not good credit risks, either because they have too much debt already, or because they don’t pay their bills on time. …
When the primary borrower defaults, you’re on the hook, not just for the loan, but for any late charges or collection fees that may have accrued. If it’s a car, the repo man will sell it for cheap at auction, and then sue you for the difference–there are no “non-recourse” auto loans. Meanwhile, your credit will be trashed. Contracts don’t always include notice requirements for the secondary borrower, so you may not even find out about late payments until it’s in collections.
Of course, the Wisest of All Men already warned of this three milleniums ago:
א בְּנִי, אִם-עָרַבְתָּ לְרֵעֶךָ; תָּקַעְתָּ לַזָּר כַּפֶּיךָ.
ב נוֹקַשְׁתָּ בְאִמְרֵי-פִיךָ; נִלְכַּדְתָּ, בְּאִמְרֵי-פִיךָ.
ג עֲשֵׂה זֹאת אֵפוֹא בְּנִי, וְהִנָּצֵל– כִּי בָאתָ בְכַף-רֵעֶךָ;
לֵךְ הִתְרַפֵּס, וּרְהַב רֵעֶיךָ.
ד אַל-תִּתֵּן שֵׁנָה לְעֵינֶיךָ; וּתְנוּמָה, לְעַפְעַפֶּיךָ.
ה הִנָּצֵל, כִּצְבִי מִיָּד; וּכְצִפּוֹר, מִיַּד יָקוּשׁ.1
טז לְקַח-בִּגְדוֹ, כִּי-עָרַב זָר; וּבְעַד נכרים (נָכְרִיָּה) חַבְלֵהוּ.2
MCARDLE: The data is a little bit hard to come by. But according to the FTC, depending on the kind of loan, up to 75 percent of the primary borrowers may end up defaulting on these loans, which means not only that the cosigner is going to be on the hook to pay it – something that they really usually don’t expect – but also that it’s going to go on their credit history. You know, when that loan isn’t paid, you often don’t get noticed until it’s in collections.
CONAN: Well, how does that work? You’re the cosigner. What’s the collection process like?
MCARDLE: Well, it really depends on, first of all, the state and, second of all, the contract. But in a lot of these contracts, there is no requirement of notice to the co-payer that they’re late. You don’t find out until they’ve looked at the primary borrower’s balance sheet, looked at yours, and decided that you’re a better collection debt.
(SOUNDBITE OF LAUGHTER)
CONAN: And many parents can find themselves in that situation pretty quickly.
MCARDLE: Absolutely. A lot of people assume that when you cosign a loan that they will go after the primary borrower and that they will basically only come to you after they’ve exhausted all of their attempts to collect. And in a lot of places, that’s actually the opposite of the truth. They have total discretion as to who they want to collect from. And when they’re looking at it, who are they going to pick? Your kid who has no job and lousy credit, or you with lots of savings and a solid job with wages that you can garnish? I mean, it’s usually a pretty easy decision.
McArdle is telling us that a cosigner (under American law) is generally an Arev Kablan, rather than an ordinary Arev.
Update: I forgot a hat tip to Zach Kessin for linking to McArdle.