I Co-Signed a Loan that Defaulted; What are My Rights?

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If you ask any finance professional what s/he thinks about co-signing a loan for a friend or family member, the advice is always: Do Not Co-sign a Loan! However, when a loved one is in trouble, most of us simply want to help – no matter what the professional advice may be.

Be aware that once you sign your name on that dotted line, you are just as responsible for the loan as the main borrower. Although you may have an agreement in place between yourselves, in reality, if anything happens to the borrower’s ability to repay the loan, you’re on the line for it.

When you initially co-signed the (school, car, home, or other) loan, you more than likely had full confidence that the borrower would simply make the payments as scheduled, and you’d be off the hook. As we all know, the only constant in this world is change. If the borrower’s financial situation changes drastically, s/he may default on the loan.

What does it mean to default on a loan?

“Defaulting” is defined as failure to make scheduled payments on a loan. Your loan is considered to be defaulted as soon as you miss one payment. Delinquencies of ninety (90) days or more will be reported to credit bureaus, and the borrower’s credit (along with any co-signer’s credit) will begin plunging downward – rapidly.

The main borrower defaulted on the loan I co-signed. Am I on the hook for the payments?

By co-signing a loan, you are promising the lender that if anything should prevent the borrower from paying, that you will make the payments in their stead. So, essentially, YES, you will be held just as responsible for the loan as the main borrower, and the bottom will drop out of your credit score if you simply do nothing.

However, you do have options that can potentially make this type of situation bearable if the borrower is willing to work with you. Most people want to do right by the person who co-signed for them.

  • Ask for a forbearance. This will work only if the borrower’s inability to pay is extremely temporary, and if the lender is willing to give him/her a month or two to get things together. A forbearance is basically a brief “time-out.”
  • Refinance the loan. If the borrower is having trouble making the payments but would be able to pay if the monthly amount was reduced, refinancing the terms of the loan may be the right answer. If the borrower doesn’t want to refinance, you can refinance the loan on your own and remove his/her name from the paperwork altogether. This is risky, though, and you may never collect any rent or further payments from the original borrower. In this case, though, you’d be the sole owner of the property/home/vehicle, and could take possession if necessary. This option would undoubtedly cause a lot of friction, but the situation was probably already pretty tense given the face that the borrower defaulted on a loan and left you hanging.
  • File for bankruptcy. Unless you co-signed for a student loan, filing for bankruptcy will allow you to discharge the loan and start fresh without it hanging over your head. Bankruptcy will lower your credit score and will remain on your credit report for 7-10 years. On the flip-side, having a loan that you can’t re-pay will also tank your credit score, and it will stick around on your credit report indefinitely.

Admittedly, none of the above options sound fun, or easy. That is why it’s strongly recommended that you never co-sign a loan in the first place. It can be a horrible mess if a default occurs, so do yourself a favor and co-sign only with your eyes wide open to all of the potential outcomes.

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