I Co-Signed My Cousin’s Loan, and He Defaulted. What to Do in This Scenario

One may need a loan for multiple reasons: higher education, buying a house, supporting a cousin in studies, or starting a business. Banks need a good credit score and income to give a bigger loan. Often, families think of combining their incomes and credit scores to strengthen their loan application. You think that you and your cousin will work together, plan timely loan payments, and have an emergency reserve to make payments during a cash shortage. You co-sign the loan, but years later, the cousin runs into financial troubles and misses multiple payments.

What next?

The bank comes knocking at your door, asking you to make the payment. By co-signing, you legally gave the bank the authority to recover the loan amount from you if the borrower defaults. There are more consequences for the co-signee if the loan defaults.

The Risks of Co-Signing a Loan

The co-signed loan appears on your credit report, which means your credit score is now tied to the primary borrower’s timely debt payments. If the bank knocks on your door, demanding debt payment, you can’t say no because not paying has its consequences.

• Missed payments stay on your credit report for seven years and could affect your chances of taking a new loan. So you don’t want your cousin to miss any payment.
• But if missing payments are prolonged, the lender could hire a collection agency or sue you as the cosigner for the unpaid balance. You will not only have to repay the loan but also bear attorney fees and court costs.
• And if your cousin goes bankrupt or files a Consumer Proposal with a Licensed Insolvency Trustee, you, as the co-signer, are responsible for repaying the full amount.

Many Canadian couples don’t realize that a co-signor’s responsibilities do not die after divorce. You will face the above consequences if your former spouse defaults on the co-signed loan. Such is the burden of debt.

How Can You Protect Your Finances from a Loan Default as a Co-signer

There are three parties to a co-signed loan: the lender, the borrower, and the co-signor. Depending on the intensity of the default risk, you can negotiate with the lender, help the borrower work out their finances, and protect your financial health. The effort is always to prevent a default if you cosign a loan. If the payments are already missed and the loan has defaulted, the effort is to protect yourself. Let’s see what options you have with the borrower, lender, and your personal finances.

Negotiate with Lender

If your cousin has missed one payment and is likely to miss the other one, talk to the lender to work out the following options:

• Negotiate a Reduced Payment: If the borrower has no capacity to pay the loan and you can’t afford to pay the monthly installments, you can negotiate a reduced payment with the lender.
• Seek Forbearance. The lender could pause or reduce loan payments for up to 12 months if it finds the borrower’s financial situation eligible for forbearance. The borrower will get some time to improve their finances. You can help your cousin get a job or find a way to help him set his finances straight to be able to pay loan installments after forbearance relief ends.
• Look For an Option to Get Released from The Loan: You can ask the lender to release you from the loan liability, and the lender may agree under certain conditions. The lender may ask you to pay a portion of the loan or agree to free you after the borrower makes x number of positive payments in a row. When co-signing a loan, read the rules carefully.
• Negotiate to Limit Your Liability for the Loan: The lender may limit your liability for the loan if someone is willing to replace you as the co-signer, or there is more than one co-signer, or the borrower has repaid most of the loan.

Preventative measures:

If you are in the process of co-signing a loan, take the following steps:

• Ask the lender if they can send you monthly statements and notify you of missed payments so you can take steps to prevent further damage.
• Ask the lender for an option to limit your co-signing responsibility to a specific period. Some banks may only require a co-signer for the first year of the loan.
• After the loan is repaid, end your co-signing responsibility properly. You could ask the lender to return the original loan document to you. If that is not possible, ask for a written document like a letter of acknowledgment, a copy of the borrower’s discharge, or your release from the liability.

Borrower

Refinance Debt: If the borrower is unable to keep up with debt payments, you could suggest that they refinance the debt in their own name. Many lenders offer debt consolidation loans. However, credit score and financial health would be reviewed there, and if a new loan is offered, it may not be on favourable terms.

There is not much you can negotiate with the borrower after they default. Hence, any negotiations and measures you take should be undertaken when co-signing the loan. A financial advisor can help you mitigate the co-signing risk.

Plan the Loan Lifecycle with the Borrower: Many parents co-sign their child’s student loan for an undergraduate program. There could be several such scenarios where you co-sign despite knowing the risks.

• Know the Risk: Have an open conversation with the borrower. What do they need the loan for? How do they plan to repay the loan: their income, existing debts, and payment reliability. See if the borrower can afford to pay the loan.
• Plan for Missed Repayments: Also, discuss a plan to handle missed payments to avoid friction in your relationship. Before the bank comes knocking at your door, it is better to hear from the borrower.

Protect Your Interests: You might want to protect your finances if things go south.

• Secure Co-ownership of Asset: If the co-signed loan is to buy an asset like a vehicle or property, ask to be a co-owner. This will help reduce the risk of the asset being sold without your permission.
• Seek Reimbursements from the Borrower: You can have a separate agreement with the borrower that they will reimburse you for the payments you make on their behalf if they default.

Personal Finances

• Always consider the worst-case scenario and cosign only the loan amount whose monthly payments you can afford.
• Check your credit report regularly for the outstanding loan balance and any late payments or delinquencies on record. If so, you can take action sooner rather than later.
• Close Accounts: If you have co-signed loans for your ex-spouse, close those loans upon divorce, either by repaying them or obtaining new loans without the co-signer. Leaving those co-signed and joint accounts open exposes you to your previous partner’s credit risk.

Often, people with good credit scores and stable finances get dragged into bankruptcy because they co-signed a loan without taking appropriate measures. A financial advisor can help you avoid falling into the debt pit and make appropriate financial decisions.

Contact Black and Gill LLP in Toronto to Help You with Personal Finances and Debt

Talk to a professional business advisor to help you use your money responsibly and protect it from several risks. Planning your finances is not just about investing, but also about mitigating risks. At Black and Gill LLP, our business advisors can provide services such as wealth and tax planning and debt management. To learn more about how Black and Gill LLP can provide you with the best advisory services, contact us online or call us at 416-477-7681