When you have a good credit score, lenders may not be the only people who notice. If you have a reputation in your family for being financially responsible, always paying your bills on time or not carrying credit card debt, you may be asked to co-sign a loan for them.
What Is a Co-Signed Loan?
Co-signing is a common practice for banks and lenders. When you co-sign a loan, you agree to pay back the loan if the borrower defaults. Co-signers are typically people with a good credit score and established credit history. That makes it easier for them to get a loan application approved, and they qualify for lower interest rates. Co-signing often makes it possible for people to access credit for the first time and begin establishing their own credit histories.
Rewards of a Co-Signed Loan
Agreeing to become responsible for someone else’s debt if they can’t repay it is a big decision, but there are several reasons you might agree to it if a family member were to ask.
- You Help the Applicant Qualify for the Loan
People borrow money for all kinds of reasons. Most commonly, family members will ask someone with better credit to co-sign a loan for some constructive purpose, such as going to school, buying a vehicle, or opening a business. Without your help, they likely would not be able to access that financing, and not be able to pursue that goal.
- The Applicant Can Start Building Credit
When you don’t have a credit history, it can be hard to qualify for credit and begin building your own. Co-signing on a loan helps the borrower start to establish their own good credit. It’s something you might do as a parent when your kids are getting their first credit card, or co-signing on your kid’s first lease when they move out.
- Qualify for Lower Interest Rates
If you have a superior credit score, you can qualify for lower interest rates. A better credit score and history show lenders that you’re less of a risk to the lender and more like to make all of your payments on time. Riskier lenders are stuck paying higher interest rates to offset the risk the lender takes. That’s how lenders ensure they earn money. Taken as a whole, riskier lenders need to pay more to make up for others defaulting. Lower interest rates make it easier and cheaper for the borrower to pay it back.
Downsides of Co-Signing
As for the downsides of co-signing a loan, there are several. First, even if you are not the borrower, co-signing affects your debt-to-income ratio (DTI). The monthly payments on the loan factor into your DTI even if you’re not the one making them, which could affect both your credit score and your own ability to qualify for future financing.
The other downside is the obvious one: if the borrower defaults, you become responsible. When a family member asks you to co-sign, keep that in mind. If they simply have no credit history and need help, it’s probably safer than if they have a history of defaulting on their debts. You should also consider whether or not you can afford it if they default. Late and skipped payments all appear on your credit report.
What Happens When the Borrower Goes Bankrupt?
If the borrower of the loan makes use of bankruptcy services because they can’t afford to repay their debt, the co-signer becomes responsible for paying for the full debt less any funds recovered from the bankruptcy process.
The terms of repayment can be a bit complicated. The party responsible for the loan after the other party has filed for bankruptcy must repay the debt minus what the creditor could receive from the bankruptcy (i.e., the proceeds from selling excess assets or surplus income payments).
However, funds from the bankruptcy will take at least 1 year to be collected. Not only does it take time to sell excess assets, but part of the money may come from surplus income payments made by the bankrupt on a monthly basis. The bankruptcy process can last 21 months if surplus income payments are involved.
In the meantime, the co-signer responsible for the loan will still have to make repayments, whether in full or installments, long before the distribution of proceeds from the bankruptcy.
What Goes Unaffected in a Bankruptcy?
When you seek out bankruptcy assistance, a Licensed Insolvency Trustee will explain what happens and how it works, including what assets will and won’t be affected. Filing for bankruptcy doesn’t mean losing everything. There are a number of exemptions outlined both federally and that are unique province by province.
As outlined in the Bankruptcy and Insolvency Act, bankruptcy proceedings do not affect:
- Property held in trust by the person filing bankruptcy,
- Contributions made to an RRSP more than 12 months before the bankruptcy,
- GST credit payments related to essentials,
- Property exempted by provincial legislation.
In British Columbia, provincial exemptions include:
- Equity in your home up to $9,000 (up to $12,000 in Victoria and Greater Vancouver),
- Necessary and essential clothing and medical aids,
- Work and business tools, to a limit of $10,000,
- One vehicle to a limit of $5,000 in equity,
- Household items up to $4,000.
Especially when it comes to the limits of equity on your home, bankruptcy can seem intimidating. If you’re worried about losing assets in a bankruptcy, or you have a family member who is, you may be able to find an alternative to bankruptcy like a consumer proposal. Consumer proposals set new terms of payment with your creditors and often include debt elimination.
Bankruptcy on Vancouver Island
You can get help with bankruptcy on Vancouver Island by visiting any of our G. Slocombe & Associates offices. Our goal is to inform the people who come to us for help what their options are, and how they can manage or get out of debt. We have the answers to your questions.