The other day a client contacted me with an issue. Unfortunately, I had to give the client some bad news. The client’s situation is that about five years ago after her daughter got married, she co-signed a loan so that her daughter and her new son-in-law could start a business. The loan was for 10 years and for the first few years, payments were made on time. Unfortunately, about a year or so ago the daughter and son-in-law got divorced and closed their business. According to the divorce settlement, the husband assumed responsibility for the loan. Not unexpectedly, about six months after the divorce they each filed for bankruptcy; as a result, their liability on the business loan was discharged. Unfortunately, no one in the divorce proceedings took into consideration that my client had co-signed the loan. As a result, the bank contacted her and informed her that unless she paid the loan, they would begin legal proceedings. My unfortunate job was to inform my client that she is responsible for the loan. Although her now ex-son-in-law and daughter were legally discharged from the loan, that had no effect on my client. As a result, as I informed her she was responsible for the loan.

At least a few times a year I am faced with the issue of having to inform a co-signer that they are responsible for a loan. Many people are under the misconception that if the primary signer of the loan goes into bankruptcy and receives a discharge that somehow that discharge applies to the co-signer; it does not. In fact, if you take a step back, that is the reason why banks and other financial institutions many times will require a co-signer in order to approve the loan. I always tell people before you co-sign a loan you have to accept the very real possibility that you can legally be on the hook to repay that loan. That is why I always say before you co-sign a loan you better thoroughly think it through.

I recognize that family and friends want to help each other and obviously, that is a good thing. However, when it comes to co-signing a loan you definitely have to think through the consequences. In other words, if you are forced to repay the loan, how will it affect you financially? If it would cause financial distress then you probably should pass on the co-signing. On the other hand, if it would have minimal impact on you then that is another thing.

There is a reason why banks and financial institutions ask for co-signers. The reason is that they’re not sure that the individual requesting the loan has the wherewithal and the financial resources to repay the loan. That is why they ask for a co-signer. Therefore, you always have to think twice before you co-sign. If the bank doesn’t think that they have the wherewithal to repay the loan it should cause you to seriously think about your decision.

One last note and that is to remember that when it comes to dealing with banks or financial institutions, you can negotiate some of the terms. For example, I recently dealt with a client who was co-signing a loan for one of their children. We were able to work with the bank to limit my client’s obligation to the first two years of the loan. If the loan was paid on time for the first two years, she would be removed as a co-signer. The bottom line, we were able to limit her liability and that’s something that you may also want to consider.

Good luck!
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.