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I Cosigned on a Loan That’s Defaulted. Now What?

April 22, 2014
Credit Cards
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“Neither a borrower nor a lender be, for a loan oft loses both itself and friend.” So says William Shakespeare, and he wasn’t referring to taking out a mortgage, but borrowing money from a friend.

He also wasn’t aware of cosigning a loan, because by cosigning you are taking on the responsibility for paying that loan if it goes delinquent. Alas, I speak from personal experience.

Understand your obligation

First, don’t ever cosign for a loan unless you have the means to repay it. You should assume the loan will go bad, and be prepared to have to make good on it. Never assume the person you are cosigning for will fulfill their obligation. It may sound cynical, but it actually has nothing to do with the borrower. It has to do with you understanding your obligation.

Let’s say, however, that you cosigned for the loan and it has indeed gone delinquent. It’s likely that the creditor will contact you and let you know that you are now on the hook for the loan and if you don’t pay up, you’ll likely be sent to collections. That’s the last thing you want to occur, because if the account gets sent to collections, both your co-borrower and you will suffer a major negative mark on your credit report.

First steps to protect your credit report

You want to avoid a negative mark at all costs. So you should immediately call the creditor, and tell them the matter will be worked out to their satisfaction, and not to send to collections.

First, contact your co-borrower. Assess the situation. Find out what they really can pay, if anything, and try to act as a mediator. Set up a conference call between you, your co-borrower and the creditor to work out the arrangement (if any). Afterward, privately contact the creditor and tell them that, if there is another delinquency, to let you know immediately.

It’s likely another delinquency will occur. Now you’ll have to negotiate with the creditor to make them happy. Although you have promised to pay that debt in full, you are probably none too happy about it. Even though, you may be able to take legal action against your co-borrower, you should assume you won’t see a dime from him. Salvaging that relationship is another matter. Right now, what can do about the creditor?

Work with the creditor

First, it’s good morals to pay a debt you have cosigned for. So if you truly can pay that debt off, then ask the creditor to take the remaining balance, and have them re-amortize it over whatever period you want to pay it off. Chances are the creditor will be happy to see you are serious about paying it off, and will agree to your schedule.

Perhaps, however, you aren’t certain you can pay it off in full. You should be honest. Tell them you really didn’t expect this loan to go bad, and you want to make good on it to the best of your ability.

One option is to offer a lump-sum payment that is at a discount to the outstanding balance that you pay as soon as possible. A good calculation to make is to take the total principal lent, subtract the principal thus far paid, subtract the interest thus far paid, and whatever remains is the amount that will make the lender whole.

That’s a great number to start at, because they lender won’t be losing any money. Generally speaking, the sooner you can pay off the whole thing, the larger a discount the lender may be willing to take. The longer you stretch out the payments, the more they’ll want.

Unfortunately, the lender has the ultimate leverage – dinging your credit report. Whatever settlements you reach, get it in writing with the promise that no negative information will be posted to credit bureaus as long as you make good on payments.

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