Wednesday, September 14, 2011

You'll Get Your Money - I Guarantee It

A series of exchanges from a recent online financial advice column:

"Hi. My nephew is going into business for himself. It's a business I don't know much about (green energy stuff), but he's a smart kid, and I think he's going to do well. But being young, he doesn't have a whole lot of money, or a very long credit history, so the banks he's approached haven't been jumping at the chance to finance him. He says one bank is willing to loan him the money he needs, but only if someone with a good credit history will co-sign the loan. He's asked me if I would co-sign. What should I do?

"Sam in DC" 

Dear Sam -
Co-signers typically will have well-established credit to help the borrower qualify for the loan. But being a co-signer isn't like giving a person a reference on a job application. It carries a weighty responsibility and some potentially significant implications that need to be understood before it's taken on.

That's because you're not just vouching for your nephew's ability to repay the debt, you're promising to pay it yourself if he defaults.

Most people would probably say, "That's fine. My (insert relative or friend) since third grade has a good job, is very responsible and will make every single payment."

And that may be absolutely true. It's also true that unanticipated things happen. People lose their jobs, they get sick and they die unexpectedly. If, for whatever reason, the borrower doesn't make the payments, you're on the hook.

You need to consider your nephew's character and ability to make the payments, and whether you could afford the debt if he defaults.

The main thing you need to understand is that you are signing that loan for a reason. If the loan goes bad, you have to pay it back. You need to look at this as if you  were taking out the loan yourself.

The FTC puts the situation into simple terms in its information on co-signing. You're being asked to take a risk that a professional lender has decided not to take.

The risks are real and significant. The lender doesn't have to exhaust every possible means to get the money from the borrower before he comes after you. The bank can select which debtor he wants to pursue. He'll pick the one who is the most likely to pay the quickest.

A few months later:

"Hi - remember me? My nephew had started his own business and needed someone to co-sign his loan. You told me the risks involved, and after weighing them as best I could (I really don't understand this green energy stuff his business is about), I decided to co-sign the loan anyway.

"Now my second nephew is going into the same line of business and he also needs a co-signer to get a loan. Since the first one seems to be working out, I'm going to co-sign for him also, even though the amount he needs to borrow is about twice what my first nephew borrowed. I think it should be okay, even though my credit score is a little lower than the last time I had checked - I guess some lenders are a little worried about my ability to pay my bills, even though I've never in my life missed a payment, or even been late.

"Sam in DC" 

A few months later:

"Hi, it's Sam in DC again; hope you remember me - I co-signed on loans for my two nephews so they could start their own green energy stuff businesses.

"I guess I should have listened to you. Nephew #1 told me he's burned through all the money the bank loaned him and his company isn't selling nearly enough of his green energy thingies to pay to keep the lights on, never mind pay his employees or pay the bank back. So he's going out of business. And now his bank is coming after me to repay the loan. I'm not happy about it, but I guess I can afford it. My nephew says there are federal investigators looking at his business records; they evidently think he might have done something criminal, and people are asking if I was somehow involved.

"I'm still guaranteeing the loan to nephew #2, but now I'm worried. Is there any way I can get out of this?

"Sam in DC" 

Dear Sam -
You are well and truly screwed. When the federal government tells you co-signing on a loan is risky business, don't you think you should listen?

 A few minutes later:
"I am the federal government."

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