Lenders need to be assured that borrowers are capable of paying off loans. A borrower can use their credit score to prove that they have a consistent and responsible repayment history. They can reveal their income to show that they can manage to fit new payments into their budget. They can show off savings accounts and insurance plans to prove that they have financial safety nets. They can offer up assets as collateral.
Sometimes, all of those steps aren’t enough to get a loan approval. This is where a co-signer comes in. A co-signer is a person who agrees to pay a borrower’s debt if that person ever defaults on their loan. When they sign on the dotted line, they agree to take on the repayment responsibilities at the very moment that the main borrower can’t fulfill them. Many lenders will agree to this back-up plan and approve the loan.
The approval is good news for the time being, but what happens to the co-signer if a borrower can’t make the payments anymore? What happens if the borrower files for personal bankruptcy?
The Risk of Co-Signing
Acting as a co-signer puts you in a precarious situation. The moment that you sign the agreement, you are liable for the entire loan. You’re not liable for half — you’re liable for 100% of it. That’s what makes co-signing such a serious financial decision. You’re agreeing to take on the entire burden for someone else.
Now, if all goes well, you won’t have to think about the loan whatsoever. The person that you helped will make all of their repayments on-time until the entire amount is completely paid off. As long as they follow the rules and nothing goes wrong, you don’t have to worry about anything.
The problem comes when the primary borrower can’t make repayments. If they aren’t fulfilling their duties, you are fully responsible for doing them in their stead. There are serious consequences for co-signers who had their borrower default on their loan repayments. You will be expected to handle regular and overdue payments, along with additional fees and penalties. If you miss payment dates, then the creditor can sue you and use wage garnishment to get what they’re owed. Your credit report will show these missed payments, effectively lowering your score/rating.
The biggest risk that comes with co-signing is that you can jump into dangerous debt because of someone else’s financial instability. It will be incredibly difficult to manage the borrower’s repayments, along with your other responsibilities every month. Considering the length of some loans — for instance, a mortgage on a house — you could be forced to juggle a lot of expenses for years of your life. It’s not sustainable. You can go deep into debt and become insolvent.
What Happens If They File for Bankruptcy?
The borrower that you’re helping is in deep financial trouble, so they decide that their best course of action is filing for personal bankruptcy. So, what happens to you as a co-signer? Are you free from your responsibilities regarding the loan?
When someone files for bankruptcy, their assets are vested to a licensed insolvency trustee (previously known as a licensed bankruptcy trustee). The trustee may take possession of these assets and sell them for the purpose of repaying creditors a portion of the funds they are owed. If the borrower had a co-signer on one of the debts, then the co-signer is still fully responsible for the repayment, even after the other declared bankruptcy.
The debt amount may be reduced by the bankruptcy repayment, but it’s not something that the co-signer should count on. Bankruptcy repayment will take a minimum of one year to go through. In the meantime, you will be expected to follow the same repayment schedule.
What Happens If You File for Bankruptcy?
It’s possible that they file for bankruptcy, and you’re left dealing with the loan all on your own. In this case, you might be unable to manage the payments along with your other responsibilities. So, just like the original borrower, you may feel compelled to file for bankruptcy.
If you’re wondering what do you lose in a bankruptcy and you’re worried about your assets, rest assured that there are plenty of asset exemptions in Ontario. Section 67 of the Bankruptcy and Insolvency Act has four categories in regards to exempt property:
- Property held by the bankrupt in trust for other persons
- Property of the bankrupt that is exempt from seizure under the applicable provincial law where the property is situated and where the bankrupt resides
- GST credit payments and prescribed payments relating to the essential needs of individuals
- Contributions to Registered Retirement Income Funds or Registered Retirement Savings Plans more than 12 months before bankruptcy
These are some other asset exemptions in the province of Ontario:
- Necessary and ordinary clothing of the debtor and their family. (No limit)
- Household furniture, utensils, equipment, food and fuel contained in and forming part of the debtor’s permanent home up to a prescribed amount or $11,300.
- Business tools, instruments and other chattels not exceeding a set amount or $13,150.00.
- An automobile up to a prescribed maximum value or $6,600.00.
- Most pension plans and life insurance policies.
- Equity in principal residence if it is less than $10,000. (If the equity is more than $10,000, there is no exemption at all)
Click here to learn more information about our personal bankruptcy services like how long it will take, what it will do to your credit and what you can do after it’s over.
Can You Take It Back?
What if you’ve already signed on for this role? There are options to remove your name from a co-signed loan out there, depending on the type of loan you attached yourself to. Some loans will have co-signer release application, which can free you after a certain number of repayments have been made. Or, over time, the other borrower can refinance the loan, and then have you removed from the newest version.
These options aren’t available with all loans and aren’t likely if the repayment hasn’t been going well. The savviest thing that you can do about co-signing is to avoid doing it in the first place. Lend your pen, not your signature.
What to Do When You’re Asked to Co-Sign for Someone:
You can see from this post that acting as a co-signer puts you in a precarious situation. If you are not prepared to take on a significant loan, you could turn your life upside-down for someone else. You’re putting more than your money on the line. You’re putting your financial stability and your comfort there, too. So, when someone asks you to be their co-signer, you should consider the following.
Look for the Warning Signs
Putting your faith in a borrower’s financial stability is a huge risk. So, instead of assuming that everything will be fine when you sign the loan, you should check to see if they’re really as financially reliable as they need to be. Before you pull out your pen, look for red flags.
One of the biggest signs of financial trouble is that they’re dipping into their savings funds for basic expenses. They are sabotaging their future goals in order to meet their present needs. This means that they are not managing their current payments well, and they are comfortable with making reckless financial decisions. If they mention taking money out of their RRSP or emergency fund for their bills, they aren’t an ideal borrower.
Or maybe you’ve noticed that they’re living from paycheque to paycheque. They’re not alone. Research shows that an estimated 53% of Canadians live from paycheque to paycheque and are unprepared for any type of financial emergency. If the borrower lives like this, they could easily miss an important payment when they make a budgeting mistake or when an unexpected expense pops up. Every month, you’d be waiting to swoop in and save them.
Another financial red flag is that the person is constantly asking for personal loans, and they don’t repay them in a timely manner. You’ve noticed that they’re always borrowing money from their friends and family members and that they’re always behind on getting the money back to them — or worse, they don’t get back to them at all. If they can’t manage to repay these tiny loans, how will they fare with a much bigger one?
Even the fact that they need a co-signer is a red flag. Financial institutions know which clients are “high risk” and “low risk.” If the borrower needs to use a co-signer to get approved, they are going to be “high risk.”
The Family Card
People ask friends, business partners, romantic partners and other close connections to be their co-signers. But, the most common group of people that are asked to do the deed are family members. Parents and grandparents are usually the ones who opt to sign the papers for the younger generation.
A survey from the Royal Bank of Canada found that most parents support their adult children financially. Their support can be for small costs like cell phone bills or large costs like university tuition and housing. The survey found that 96% of parents were subsidizing their children aged between 18-35. A significant number of parents still supported their children who were well into their thirties.
When the borrower is your child or grandchild, it can be difficult to refuse their plea for help. You want them to reach personal milestones like buying a house. You don’t like watching them struggle to make ends meet. You want to give them a leg up and make things easier for them because you love them. It’s understandable.
Refusing to co-sign for your children/grandchildren might make you feel like a bad parent/grandparent. But, if you can’t handle the risk, you should gather up the courage to say “no” to this request. It’s in your best interest to do so. As a firm with some of the top rated bankruptcy trustees in Toronto and the GTA, we have seen many clients over the years who could have avoided bankruptcy if they had not acted as a co-signer on a loan.
The roles can be reversed, too. Lots of adult children feel the pressure to financially support older parents who are experiencing financial instability because of problems like divorce, illness or loss of regular income.
Refusing to co-sign for your parents will also be difficult. You might feel guilty for not being able to help your parents with these milestones, especially after they’ve helped you throughout your life. You might feel the urge to sign to make them proud or happy, but try not to let those desires get the best of you.
Looking for a Different Solution
Now, “just say no” isn’t always a realistic solution, especially when you’re dealing with a family member who is depending on you saying “yes.” If you really want to help, consider broaching options that don’t require co-signing. You can find a positive and proactive solution that won’t put your financial stability at risk.
For instance, if your relative was hoping to take out a mortgage on a house, but can’t afford the loan without you, suggest renting a spacious apartment instead. A rental is much more likely to be in their financial comfort zone. From that point on, you can join them in apartment hunting. You can pick up boxes and carry furniture on move-in day. You can even get them a generous “house-warming” gift.
If the main roadblock seems to be their bad credit score, suggest that they take some time to fix that before seeking out another loan. A single rejection doesn’t mean that they should turn to desperate measures. After dealing with their score, they can always give the loan another try.
One simple way to improve their credit is to take credit counselling from a licensed insolvency trustee. With a trustee’s expert guidance, they could eventually push their score into a higher category and encourage lenders to approve their loans without any need for a co-signer. Click here to see more information about our credit counselling services — or send the link to your relative in need.
At the end of the day, you shouldn’t feel obligated to put yourself in a tough spot to make someone else happy. There are lots of ways that you can be helpful without co-signing. Work together to find a satisfying solution.
Residents of the Greater Toronto Area have had their lives turned upside-down by the pandemic of COVID-19. Here at David Sklar & Associates, we understand that many residents have been thrown into financial instability because of this health crisis and are concerned about what to do next. If you need financial help, we are still here for you. We offer over-the-phone consultations, video consultations, and electronic document signing so that you can access our services from the safety of your home. We want to encourage our clients to prioritize their health as best as they can during these uncertain times.