June 5, 2007

Dangers of Co-Signing An Auto Loan

Co-signing a car loan always seems like a good thing at the time. Often, the arrangement is based on optimism and affection. A friend or family member’s credit simply comes up a little short. The bank wants a second name on the signature line.
So, Dad might co-sign on a teenager’s first car, an aunt might help a temporarily unemployed nephew who needs wheels, or a girlfriend might use her good credit to help out her new flame. “Trust me,” he says, I’m going to get that job.” In rare circumstances, co-signing might be offered for something else – there is one reported case in which co-signing on a loan for a Chevy Blazer was offered by a murderer in exchange for aiding and abetting the crime. It’s amazing what financial desperation will do.
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Under California law, a co-signer is someone who executes a car loan or lease (actually it can be any vehicle – car, truck, motorcycle, RV) but does not in fact take possession of the vehicle.

In fact, co-signing is almost always a bad idea. Rarely does the co-signer realize he or she owns the car, is liable on the financing, and may be liable to victims in the event of a crash. The first problem is that, without possession of the vehicle, the co-signer has no control over whether loan payments are made and no control over whether the vehicle will be safely maintained. The second problem is that the legal obligation often outlasts the relationship.

In one case, a mother co-signed a loan on a used Mercedes for her 25 year-old son, who lacked credit of his own. The mother never drove the car. Time passed and the son married. Marriage did nothing for his mechanical abilities and he failed to maintain the car. The brakes went out and in the crash that followed, a pedestrian was pinned between the Mercedes and some machinery. The injured man sued the mother, who was found liable as an owner of the vehicle. She was undoubtedly surprised to learn that in California there is a non-delegable duty to maintain the brakes on one’s car, and her “mere” co-signer status did nothing to distance her from that duty.

Then there are the loan payments. The co-signer has given her good credit standing to obtain the loan, and the lender has relied on that credit in support of the borrower’s ability to repay. The problem few people consider is that if the borrower had the ability to repay, there would be no need for a co-signer in the first place. What does the co-signer know about the friend or relative that the finance company does not? Love may be blind, but banks are not. The co-signer need to give serious thought to whether this is in fact an unaffordable loan. Often it is a better idea to lower the borrower’s sights -- perhaps it would be better to wait a month to save enough cash for a larger down payment and reduced monthly payments, or maybe a used car would do just for now. At the very minimum, every co-signer should take a calculator along and do the math. If the primary borrower is unable to pay, would the co-signer be able to cover the payment in order to protect his or her own good credit?

And what about notification of a failure to pay? If the buyer and co-signer do not share a mailbox, the latter may not even know of a default in time to fix the problem. The co-signer should think it through: “This is a 5 year loan. Where will I be in the next five years? Could my own employment or credit needs change? Is the borrower for whom I’m signing likely to be able to pay this amount throughout the whole term? Who is covering the insurance? And how will I know if circumstances change?”

Too often, a co-signer first learns of a problem is when she gets a Notice of Delinquency personally served, sent certified or sometimes delivered by first class mail. In California, the co-signer must get such notice at his or her own separate address, even if the monthly statements go only to the primary borrower. The absence of separate notice gives the cosigner separate rights. By the time the co-signer gets wind of a default or repossession, it may not be too late to recover the car with penalties, but the smudge on one’s credit report is a nasty stain.

Just about the only time co-signing might be wise is when a parent is assisting a teenager (who lives at home, has a known driving record and is covered by the family policy) in the purchase of a first car. The parents and child should discuss who will take care of maintenance, including tires, brakes, oil and routine check-ups. The term of the loan should not be longer than the child’s anticipated dependency – usually up to age 18 plus college. The parents should pay or supervise payment of the loan to ensure timeliness and accuracy to establish good credit. This way, the co-signer can stay on top of the loan payments, insurance and maintenance of the vehicle, while the child begins to build a valuable credit record.

We see too many instances in which there was some emotional pressure at the time of the co-signing. A single mother pressured by an alcoholic adult son; a boyfriend and girlfriend confusing money with love; a lonely (often elderly) relative wanting to feel needed. Too late, the co-signer realizes that either the optimism or the affection was sorely misplaced. There was a good reason the bank just wanted a second name on the signature line. And the trust, like the credit, comes up a little short.