Personal Finance Advice

What happens when the person you cosigned for stops making their payments?

It’s not usually something a person really thinks about before cosigning.  Cosigning is usually a quick process that most people don’t really think twice about doing even though there are major financial repercussions.  For instance, imagine that your brother - who has bad credit, by the way - asks you to co-sign for a car loan because he can’t qualify for a loan based on his credit alone.  Without your signature he’ll need to make a huge down payment and pay a whopper of an interest rate, but with your signature he’ll qualify for a loan at a decent interest rate with a low down payment.  He asks you to do him this favor, and since he’s your brother and a nice guy you agree.

Fast forward to a year or so down the road.  Your brother hits hard times after losing his job and misses a payment on the car.  The lender calls him and asks for payment, and when he says he can’t afford to make the payment the lender calls you.  You’re surprised because you had forgotten all about co-signing for the loan, and you’re even more surprised to suddenly have a lender calling you out of the blue asking for a payment.

Are you liable for the payment? If you co-signed for a loan then the answer is yes, you are.

Co-signing for a loan is rarely a good idea.  It’s like you’re telling the lender that you’re willing to be liable for unpaid balances even though you can’t enjoy any of the benefits of the loan.  If you co-sign for a credit card, you don’t get to use the card but you’re still liable for the amount due if the primary account holder doesn’t keep up on the payments.  Since you never know when a person’s finances are going to take a hit, you can never be assured that you won’t wind up paying for someone else’s debt if you’re a co-signer.

Someone may have all the intentions of keeping up with payments but then suddenly something happens and the person simply can’t meet the minimum payment due.  This makes for a real mess when a co-signer is involved.

So what can you expect to happen if the person you co-signed for stops making payments? If you’re lucky, the person will contact you before falling behind on the payments and ask for your help.  On the other hand, what usually happens is the person is too embarrassed to admit that there is a problem…or simply forgets that you co-signed in the first place.

You’ll get a letter or phone call from the lender asking for payment.  By this time there is a chance that your credit report already has a late payment listed on it, so your credit score has suffered as a result.  If you don’t make the payment, and the other person doesn’t make a payment either, then the next thing you know you’ll get notices in the mail of collection efforts that may lead to legal action.  If the amount is large enough you might find yourself going to court. 

You will encounter the same situations as though the debt was your own.

How do you avoid this situation? If you do co-sign it’s a good idea to stay in direct contact with the person and make sure that payments are made.  In an ideal situation you will have the money set aside to pay off the debt should the need arise.  Or you can just choose to never co-sign, which is a pretty solid financial decision. 

You’ve made the decision to get your personal finances into order.  You set up automatic payments for all your bills and you cut up all your credit cards.  You’re well on your way to getting all your money issues under control, but then a friend calls.  Everyone is taking a road trip, do you want to come along? Or maybe your mall buddy is heading out for a shopping tip and needs a cohort. It could be that your friends want you to meet them for dinner at a place that you know will wind up costing you much more than you budgeted for dining out.

What do you do?

You need to realize that personal finances have as much to do with psychology as they do about the contents of your wallet.  Most people have a desire to be social and to fit in with a group of people, even if it’s a small group of people.  In other words, when you are sitting alone at your desk, composing a budget and trying to get your finances in order, you probably feel like you can pull off a big cut in your spending.  When the phone rings and you get an unexpected invitation to go somewhere with friends that will probably cost you more money than you should be spending, all that resolve might fly out the window.

Why? You might be embarrassed about having to cut back, or maybe you don’t want to say no to your friends.  If you are embarrassed about your budget, you shouldn’t be…chances are the same people inviting you for a night out on the town might not have the cash to actually do so and will be funding the fun with credit cards.  If you don’t want to say no to your friends then maybe you should suggest a night out that doesn’t cost so much.  You might find that people are actually relieved to get an invitation to do something that doesn’t cost much money (or any money at all), so research the fun things to do in your area that are either free or close to free.

Or maybe you just need to find some other people to hang out with who don’t have seemingly unending access to money.

How can you solve this problem quickly? Make a declaration to your friends: “I am going to stop spending so much money.”    If your friends know that you intend to stop throwing your money around for frivolous purchases then maybe you won’t have to deal with someone calling and asking you to pack up and head to Las Vegas for the weekend.  Instead of hiding the fact that you’re going to try to live on a budget, advertise it.  Not only will your friends know to not expect you to open your wallet every time they want to go out, but you might inspire someone else to take a hard look at their finances too.

If your friend tells you she just put all her money into CDs, chances are she means she placed her savings into a certificate of deposit at a financial institution as opposed to spending her life savings on compact discs of her favorite bands.  What’s a CD? It’s a place to put your money that loses and gains favor with consumers as the stock market fluctuates.  When the stock market is thriving, some people balk at the idea of CDs as too conservative.  When the stock market is in trouble, CDs suddenly come back into favor among people looking for somewhere to put their savings.  As the stock market grabs more attention for being volatile, prepare to hear a lot more about CDs.

CDs are offered by financial institutions as a high-yield savings account that the consumer does not access until a certain amount of time has passed.  When you buy a CD you buy it for a certain amount of time, commonly anywhere from six months to five years and beyond.  CDs usually offer an attractive interest rate - it’s oftentimes substantially higher than the interest rate offered for a standard savings account - but it’s considered a conservative place to put money since there is potential to earn more by putting money into investments.

CDs are also considered safe.  This is because you are guaranteed a certain return for the money you deposit into the CD.  You have different options with CDs, depending on what the financial institution offers:

Compound Interest or Disbursements:  You choose whether the interest earned will be added to the balance of the CD or instead disbursed to you as it is earned.  For maximum earnings, the interest should be added to the balance so you can enjoy compound interest.  Some people choose to have the interest payments disbursed because they use these funds as income to pay living expenses.

Short-term or Long-term:  Some financial institutions offer very short term CDs, but the highest interest is usually offered to long-term CDs.  Even though these long-term CDs have higher rates, many people fear locking their money into a certain interest rate for such a long time (for example, four years) because interest rates may raise in the interim but the rate on the CD stays the same.  Many people scramble to purchase CDs when interest rates are high because their guess is that interest rates will drop, making the CD with the high interest rate a very attractive product indeed.

One Rate or Laddering:  Some of the longer-term CDs offer interest rate laddering, which is where the interest rate changes at predetermined intervals.  This doesn’t mean the interest rates fluctuate with the prevailing rates of the market, but instead that the interest rates change as set forth by the original agreement.  There are no surprises with the interest rates, but with a ladder you’ll know when the rates will change at what they will change to.

Accessible or Not:  The point of a CD is that the funds aren’t accessible to the owner, and since the financial institution has access to the funds for investments and lending the interest rate is higher than a traditional savings account.  If you cash out your CD early you’ll probably lose the interest you earned - or at least a good portion of it - and you may also encounter fees for the early withdrawal.  Some financial institutions offer CDs that can be accessed at any time, but the interest rates are usually lower for these CD products.

Don’t put money into a CD if you think you may need access to the funds soon.  CDs are a good place to put money if you want to earn interest on the funds and you know you’ll use the money for a specific purpose, such as building up a down payment on a home you want to buy a couple of years down the road.  While it is true that you can potentially earn more by investing in the stock market, the potential for loss is much, much less with a CD than it is with some of the other investment options.