Cosigning For Debt and Community Property Laws
Who Is Responsible For Payment?
Liability and the legal responsibility to pay back a loan can occur either actively or passively. Active liability is when you take out a loan, are a co-borrower, or guarantee a loan as a co-signer. Passive liability occurs when you live in a community property state and your spouse acquires debt, even if the debt is not in their name.
Co-signing a loan is typically done for someone you know and trust. If your child, spouse or parents have difficulty getting a loan due to credit issues, banks will often require a co-signer. You want to help and you trust that they will pay the loan off with on time payments. Most co-signers do not expect to make payments and do not consider the credit risk involved.
Because of the liability involved with a co-signer, understanding your responsibility and the consequences that can occur is extremely important. When you co-sign for another person, you are guaranteeing the loan will be satisfied if the primary signer fails to make payments. You can be held legally liable for 100% of the balance of the loan plus any late fees, interest and costs of collection.
Lenders want a co-signer when the primary applicant has weak credit, unreliable income, or a poor payment history. A strong co-signer lowers the risk for the bank, enabling them to approve the application. These loans provide a high level of risk for the co-signer, with very few benefits. Most financial advisors recommend against co-signing a loan even for loved ones such as parents, children and spouses.
Risks of Co-Signing a Loan
- Nonpayment or late payments will appear on both parties’ credit report. This can impact your credit score for up to 7 years from the last late payment. If the primary applicant already has poor credit they may not be as concerned with paying the loan on time.
- If you don’t receive duplicate statements your credit may be damaged without your knowledge.
- In some states, creditors can pursue you before the primary borrower.
- Co-signing for a secured loan, like a vehicle, could result in a repossession of the asset. You may still be legally obligated to pay the difference between the sale of the asset and the loan balance.
- The loan debt will appear on your credit report and could impact your ability to obtain credit because it will be factored into your debt to income.
Once you are a co-signer, unless the primary applicant is able to get approved on their own, you will be unable to remove your name from the loan. If it goes delinquent, your only option will be to pay it off or deal with debt collectors.
Debt collection companies prefer to contact the co-signer because they are more likely to pay. The guarantor or co-signer generally has stronger credit and has shown greater responsibility in making payments.
Difference between an Authorized User and Co-Signer
An authorized user has the legal right to use the account, but is not responsible for payments, whereas a co-signer is 100% responsible for the debt. A case where an authorized user might appear on account is a child of a parent, an employee of company or a spouse in a state other than a community property state.
Co-Signed Debt and Debt Relief Programs
If co-signed debt is enrolled in a debt relief program like a credit card modification program or credit counseling program by the primary card holder, the credit card company can still collect the debt from the co-signer, so it is important to use a competent program provider who can protect you from future collections by correctly documenting the terms of any settlement agreement reached and ensure it extends to all parties liable for the debt. Furthermore, all account activity will be reported on both signers’ credit reports.
Bankruptcy
If the primary account holder files for bankruptcy collection companies can still attempt to collect the debt from the co-signer. A bankruptcy discharge will provide relief for the primary signer, but not the co-signer. The primary debt holder can opt to maintain the account and continue to make payments instead of having the debt discharged. They can also give the co-signer the opportunity to keep the debt current and maintain the account in their name.
Community Property States and Debt Liability
Community property states have different rules than common law states, when it comes to responsibility for debt and ownership of assets. Common law states focus on the title and when assets or debt are obtained. Community property states focus on the marital relationship. These laws most often come into play when a death or divorce occurs.
Community property states include: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska offers the ability to opt in to a community property agreement if it is done in writing.
Community property means that everything accrued during the marriage belongs to both parties. This includes both assets and debts. There are three exceptions to this rule. If you owned the property before the marriage occurred, if one spouse received a gift, or if one spouse receives an inheritance. If the gift or inheritance becomes mixed as joint assets, even these exceptions can be lost. In general all assets and debts are considered to be owned by both spouses.
In the event of a divorce both assets and debts are divided 50/50. In the event of death, the surviving spouse will be legally responsible for all the debts regardless of whose name the debt is in. Since this can create additional complications it is important to consult with an attorney to clarify what legal responsibility you will have for a spouse’s debt in the event of death or divorce.
For example: If you own a vehicle solely in your name, in a divorce the vehicle would belong to both of you. At the same time, if your spouse took out a credit card in his/her name, upon death, the surviving spouse would be liable to pay the debt, even if you knew nothing about it.
The community property laws are one of the few cases where you can acquire debt passively and be held legally liable for the repayment of the debt. In nearly every other case, if you do not sign a contract agreeing to accept the debt, you cannot be held liable for the repayment of that debt.
Conclusion
Co-signing loans may have significant financial consequences. It can damage your credit and create a liability that must be repaid. It can also harm family relationships because of the hardship it might cause.
Before co-signing any debt, be prepared to repay the full amount in the event the primary singer is unable. For this reason, even among married couples, it is a good idea to maintain separate accounts; especially when it comes to unsecured debt.