May 16, 2013 – By Geoff Williams
The advice for cosigning a loan for a family member or friend is always virtually the same: Don’t do it, and if you do, understand the consequences if something goes wrong.
But what if you ignore the advice and cosign, and the loan goes south for reasons beyond your control?
Although there is no database that tracks cosigned loans, anecdotal evidence and some data suggest cosigning is common – and it isn’t always parents cosigning for children. In 2010, LeaseTrader.com, a national car leasing marketplace, reported a 29 percent increase over the previous two years in the number of parents asking their kids to cosign a car loan for them.
So what happens if you’ve tried to help a loved one, and that loved one can’t keep up with the payments, so you’re stuck paying for his or her credit cards, student loans, car or even house? Or perhaps you also can’t pay, and you’re watching your once-sparkling credit score crash and burn. Maybe the situation is even worse, and your family member or friend won’t make the payments. What then? Are you stuck paying off the loan, or is there an exit plan?
The answer to both parts of the question is yes. Neither situation is pretty, but if your goal is to simply extract yourself from the predicament, here are some of your options.
Just how bad is this situation? If the original person doing the borrowing is willing to pay but can’t right now, and you can’t even temporarily take over the payments, you can always see if the lender will put a forbearance in place. This is essentially a temporary reprieve, usually for just a month or two, although with student loans, the time can be more generous, like six to 12 months. If you just need to buy some time, you may be able to.
Take out a loan to pay off the cosigned loan.
As Richard Lee, a partner at the Los Angeles-based law firm Salisian Lee LLP, suggests, you or the borrower might find a third party, “like a debt-consolidation company or some other hard-money private lender, willing to take a risk by financing the early payoff of the original loan and taking an assignment of the principal debt.”
The idea is that this third party pays off the debt, and the borrower – that is, your adult daughter or relative – is responsible for the new loan, Lee says. The odds of finding a lender who will do this are not good, but if you can swing it, your problems are over.
But your family member’s problems are just beginning. He or she almost certainly has shoddy credit at this point, so the new loan will likely have a much more severe interest rate or terms. You might not be able to stomach that if you think this loan has the potential to ruin your relative’s life. But everyone’s financial situation is different, and this might be the perfect solution for you, and even for both of you.
“This can sometimes be a long shot, but if the loan is through a bank that the signer or cosigner have worked with in the past, and there is history, it’s possible the bank will be willing to renegotiate the terms of the loan,” says Sue Katz, a community outreach coordinator with American Consumer Credit Counseling, a nonprofit based in Auburndale, Mass.
The problem is that lenders are most willing to refinance if the borrower and cosigner have good to excellent credit, and if the borrower has been having trouble making payments, that’s probably no longer the case.
Another point to consider: Even if you and your borrower can refinance for a smaller monthly payment, the borrower may wind up paying more in interest if the loan is stretched further into the future, from, say, a three-year loan into a five-year loan. But what if the borrower still can’t make the payments, even though they’re smaller, and you end up taking over? In the long run, you’re worse off because you’ll pay much more in interest.
“Once your co-signer has reverted to late payments or defaulted altogether, it has been my experience that your best way out is not to try and renegotiate the loan to smaller payments,” says Kristen Fricks-Roman, a financial adviser with the global wealth management division of Morgan Stanley in Atlanta.
She adds: “We often think the reason our loved ones aren’t keeping up with their responsibilities is because they can’t when the truth is they won’t.”
Refinance on your own.
As in, don’t have your borrower on board. This is, of course, a big step. You’re taking full ownership of the loan now.
But if the goal is to simply get lower monthly payments with a smaller interest rate so your borrower can pay off the loan more easily, sending payments to you instead of the lender, this might be a reasonable plan.
Still, there is plenty to consider. You thought the consequences of cosigning were bad? If you refinance the entire debt on your own – that house your son was buying, the credit card debt your nephew collected – that’s all yours now. And while the plan may be to have your co-signer pay you back, you could be left high and dry with the debt.
On the other hand, as the sole owner, you’d have leverage to insist your tenant continue to make mortgage payments, which would be smaller and more manageable, or that he or she pay rent to you. The same goes for a car. It’s yours to drive anytime you want, and you could even take possession of the vehicle and sell it, if you don’t mind frosty family get-togethers.
Recoup your money another way.
If this debt you’ve cosigned for has truly drained your bank account and you want to make your money back, Fricks-Roman has some interesting ideas.
First, with any luck, your relative or friend wants to pay you back and feels terrible about this loan gone amok. If that’s the case, you could ask the borrower to direct-deposit part of his or her paycheck into your account, Fricks-Roman suggests.
But if that isn’t going to happen, Fricks-Roman says less-appealing options include redoing your will and excluding the loan amount from it. That won’t work for everyone, especially if you’re worried about your own retirement, let alone leaving something behind in a will.
She also suggests removing your relative from your “gift list” until you’ve recouped your financial outlay. Of course, due to the size of some loans, that might be a lifetime.
It can be virtually impossible to get student loans discharged in a bankruptcy, but with other cosigned loans, this might be the way you’ll have to go.
But there’s another, more hopeful thought, Lee points out. “Even if the parents don’t want to declare bankruptcy for any of the chapters – Chapter 7, Chapter 11, Chapter 13 – it can be a useful negotiation threat to gain leverage with the original lender in renegotiating a forbearance or other type of grace period to allow the child to get back on his feet, get a job and re-start making payments,” Lee says.
In other words, even if you have no intention of ever going bankrupt, your borrower’s lender doesn’t need to know. Of course, even mentioning the word “bankruptcy” to a lender could have unforeseen consequences – the worst way to instill confidence in a financial institution is to tell them you may have to declare bankruptcy. But that’s the thing about extracting yourself from a cosigned loan. There are no good solutions to pick, only the least revolting one.