Understanding the Difference between a Co-Signer and a Guarantor.
Clients sometimes ask me about personal guarantees on loans. This issue comes up frequently with adults asking to guarantee or co-sign loans for children for the purchase of homes and cars.
The first question is whether or not the request is to be a guarantor or co-signer. These two obligations, while appearing to be similar, actually can result in different levels of exposure for the party signing as the guarantee or co-signer.
A co-signer agrees to be jointly liable for the debt of the child or partner that is asking for the assistance. The co-signer’s obligation is an equal, but undivided obligation for the entire loan or debt. For example, if there is a $100,000 loan that a co-signer agrees to participate in, that co-signer becomes a principal borrower, allowing the lender to obtain payment for 100% of the loan. It also does not require the lender to exhaust any remedies against the person requesting the cosign before pursuing the co-signer. In other words, as a co-signer, you are individually responsible for 100% of the debt.
This differs from guarantor. In this case, you are guaranteeing payment of the principal borrower. For example, when you as a parent sign as a guarantor for your child’s car loan, the lender has an obligation to exhaust all remedies against the child before it is allowed to turn to the parent for payment of the debt. Although a guarantor may ultimately be liable for the entire amount of the debt, the lender must first exhaust all efforts against the principal borrower, and must show the efforts against the principal borrower were inadequate prior to any obligation of the guarantor to pay the debt.
While the guarantor may appear to have less risk than a co-signer, the reality is if the principal borrower defaults and is unwilling or unable to pay original debt, whether you wear the co-signer’s hat or the guarantor’s hat, you’ll probably end up writing a check.
Hope for the best, but plan for the worst
If you are co-signing or guaranteeing the debt of another, you should understand that you are putting actual assets at risk, and should carefully consider the amount of debt that is included in the loan. Keep in mind that most loan documents allow for payment of the principal, the interest, default interest, and legal fees in the event of a default. This can dramatically increase the amount of risk to the co-signer/guarantor because of the multiplying effect of the cost of a default.
It is important to understand your legal obligations when signing as a co-signer and/or guarantor in case the worst should happen, for it could have a dramatic effect on your finances.