What Happens When You Cosign on a Loan & the Person Defaults?
If a friend or relative cannot qualify for a loan because of a poor credit score or lack of credit history, he may ask you to cosign the loan. Cosigning means that, although you do not directly benefit from the loan, you are obligated to repay it if the borrower defaults. If the borrower does not make his payments as agreed, you may incur several consequences.
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Collection Activity
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When you cosign a loan, the creditor may initiate the same forms of collection activity to recover from you as it can initiate to recover from the borrower. If the borrower defaults, the lender may send you late notices and payment demand letters to compel you to repay the debt. The creditor may also call you to discuss repayment, subject to restrictions imposed by the Fair Debt Collection Practices Act.
Borrower Bankruptcy
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If the borrower files for Chapter 7 bankruptcy protection, and you are not included in the bankruptcy, you will become solely liable for repayment of the borrower's debt if the court grants a discharge. However, if the borrower opts for Chapter 13 bankruptcy, which allows the borrower to reorganize his debt and repay a portion of what he owes as determined by the court, you are protected from collection and sole liability for the debt if the borrower makes his court-mandated payments.
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Civil Lawsuit
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Because cosigning a loan makes you legally responsible for the debt if the borrower defaults and does not file Chapter 13 bankruptcy, the creditor may file a lawsuit against you for the debt if you do not pay. The court will typically issue a judgment in favor of the creditor. The judgment becomes public record and appears on your credit report which may affect your ability to obtain credit, rent an apartment or even obtain a new job.
Post-Judgment Consequences
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A judgment gives the creditor additional rights that can affect you as a loan cosigner. The creditor may place a lien on personal property you own, preventing you from selling the property until the judgment debt is paid. In most states, a judgment creditor can also take funds from your bank account without your permission and garnish up to 25 percent of your after-tax wages.
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