Despite warnings from experts, people still co-sign loans for their loved ones. If you must, or already did, at least take these steps to protect yourself
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It’s a scenario few parents would ever consider: After co-signing student loans for their child, their child dies unexpectedly and debt collectors turn to the parents for repayment.
That’s what happened to 61-year-old Ella Edwards when her only child, Jermaine, passed away unexpectedly at 24. Suddenly she was responsible for more than $10,000 in private student loans. She couldn’t pay and the lender didn’t budge — she signed and so was on the hook.
“They called nonstop,” says Edwards. “I told them that my son was dead and I was trying but didn’t have the money. They didn’t care, they just called and called and I couldn’t stop crying. Every day. It brought his death back every day.”
Desperate, she used the online petition site Change.org to ask for help, titling her petition, “Forgive my deceased son’s student loan.” People were moved, none more than radio host Tom Joyner. When he heard her story, he stepped in and paid the debt off.
Such benefactors are rare, however. Today, Edwards hopes her situation will serve as a cautionary tale about the perils of co-signing.
Despite warnings from personal finance experts about the liabilities involved when co-signing another’s credit application, people still do it. Parents do it for their children. Spouses, friends, parents and siblings do it for each other. And while not all co-signing agreements end badly, many do.
If you find yourself saying yes to a request for a co-signer for whatever reason, it may behoove you to take preventive measures to offset potential troubles, urge experts. Here are 10 ways to protect yourself when co-signing.
1. Act like a bank. Lenders have a strict protocol for lending, so use them as a guide, suggests Harrine Freeman, CEO of H.E. Freeman Enterprises, a credit restoration company in Washington, D.C. “Character assessment is key,” says Freeman. For example, you can ask to examine the other person’s credit report, and ask about his job situation and budget to make sure he can easily afford the payments, says Freeman. Knowing that the borrower is on solid financial footing can give you a sense of security.
2. Review the agreement together. Once you have the credit card application or loan contract, read it over together. “You’ve got to know what you’re getting into,” says Freeman. “Both must understand the terms, especially the date the payment is expected, and what happens if you pay late.” Such clarity should help the person responsible for the account’s management understand what the requirements are for keeping the account in good standing.
3. Be the primary account holder. For added protection, consider being the primary, rather than the secondary, owner of the account. “You are legally obligating yourself to the creditor for the debt, so why not have a little more control?” says Wayne Sanford, a credit consultant with New Start Financial in Allen, Texas. The statements will go to you, and you can collect the cash from the secondary borrower to pay the bill with assurance.
4. Collateralize the deal. What else would a lender expect, especially if the applicant is new to credit or has had past money troubles? Collateral! Freeman says you could ask for an extra set of keys to the car you’ve helped someone buy, and agree that if payments are not made on time, you have the right to take possession of the car to either sell it to pay off the debt or to assume loan payments on it. Or, if you co-signed on a credit card, ask to hold onto another item of value. If she runs up a huge balance, you agree that you can sell it in order to apply the proceeds to the debt.
5. Create your own contract. “Create a simple promissory note that discusses what the obligations, costs, etc., the borrower will have if they default on payment,” says Ebong Eka, CPA and personal finance expert from Tysons Corner, Va. You can include all sorts of stipulations, such as to insist his paycheck be deposited directly into a checking account, and then for the lender to automatically draft the payments from it. This way you can be sure the money is in and then goes out on time. When both parties agree to the terms, all sign, then have it all notarized.
6. Set up alerts. Even if you’re not the primary owner, you can still hold the reigns in a hands-off manner, says Denise Winston, author of “Money Starts Here! Your Practical Guide to Survive and Thrive in Any Economy.” Set up text, email or phone alerts with the lender for when the payment is due and when it’s been posted. “This helps you stay on top of the account you co-signed for and informs you when and if you need to step in and take action,” says Winston.
7. Check in, respectfully. Meet up with the joint owner and discuss the account’s progress every few months. This way you can find out if the other person is making payments on time or not, allowing you to offset future complications. However, avoid the urge to micromanage, says Winston, as it can cause a rift. Constant phone calls and nitpicking sends the wrong message.
Create a simple promissory note that discusses what the obligations, costs, etc., the borrower will have if they default on payment.
|— Ebong Eka|
CPA and personal finance expert
8. Insure your assets. Depending on the size of the debt, you may want to consider purchasing life insurance on the primary account holder. Yes, it’s not something you like to think about — especially if you co-signed on a loan with a loved one — but things happen. The question to ask yourself when co-signing on a large sum is how financially devastated would you be if the primary account holder passed away and you were left to pay the balance on the loan? According to Soren Christensen, CEO of Advanced Wealth Advisors in Naples, Fla., purchasing life insurance could be a sensible safeguard. “The co-signer would certainly have an insurable interest since they would be on the hook for the debt if the other person died,” says Christensen.
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9. Establish trust with a trust. If the loan or credit line is especially large, you might also consider setting up a trust to protect savings and property. “For someone taking on any new possible debt liability, whether for themselves directly or as a co-signer, they should review their estate plan to make sure they have properly protected their assets from any possible future creditor demand issue,” says Christensen. Meet with a financial planner to identify the right type of trust for such a circumstance.
10. Establish an exit strategy. A joint financial arrangement should be a launching pad for the needy borrower. “Twelve months is a solid timeframe” to rebuild a credit score enough to, say, refinance an existing loan or apply for a new credit card without your signature, says Sanford. Then, ask the existing issuer if they’ll remove you as a joint owner from any old accounts. If they can’t, consider canceling it. Both of you might experience a slight credit score reduction, but it may be worth it to break free.
Co-signing is serious business, so only do so only after taking the proper precautions. Unless an angel investor comes to your rescue — as Tom Joyner did for Ella Edwards — getting mad at the lender if you get stuck with credit damage and debt will be useless. When you autograph that paperwork, the contract is binding.
See related:How to get out of a co-signed loan, credit card, Options are few when a co-signed credit card goes bad, Can you remove co-signed loans from credit reports?, Is co-signer at risk if bankruptcy looms?