By: William J. O’Sullivan
How often have you seen this letter in an advice column? “Dear Columnist: When I got divorced, I got the house and the judge ordered my husband to make the mortgage payments. Now my husband has stopped paying and the bank is threatening foreclosure. How can this be?”
Or this one: “I lost my job six months after I co-signed my son’s car loan, and I sent the bank a letter telling them that they would have to get the payments from my son. But they keep sending me demand letters. Why won’t they leave me alone?”
Because people can give away houses and cars but they can’t give away debts, that’s why. But unfortunately, people go into debt with friends, lovers, business partners and family members without really understanding the nature of the obligation – until it’s too late.
To get to the bottom of this, let’s look at a typical loan to multiple borrowers.
First, when two borrowers are involved in a bank loan, the papers usually say that their liability is “joint and several.” This means that the bank has complete discretion to pick and choose whom it will collect the debt from. This is so even if one borrower is simply a guarantor for the other. If the loan is for $100,000, the bank can collect the whole $100,000 from one borrower, and ignore the other.
In our example, there are three parties to the loan agreement: the bank, and the two borrowers. The agreement can be modified only if all three parties agree. So no matter what the two borrowers agree to between themselves, they can’t change the bank’s rights. The bank can still choose its target as it pleases.
What the borrowers can do is make a side agreement between themselves. They might decide that, if one of the two borrowers is forced to pay more than a certain percentage of the loan, then the other borrower will reimburse her for the excess. But that type of agreement, which is typically called an indemnity agreement, has no effect on the bank’s rights. Its effectiveness depends on each partner’s willingness, and ability, to honor the side agreement.
This is true even if a judge orders one of the borrowers to pay the loan in full, as often happens in divorce proceedings. In such a case, the judge obviously has authority over the husband and wife, but not over the bank, since the bank isn’t a party to the divorce action. The judge can enter a payment order that is binding on the co-borrowers, but can’t deprive the bank of its contract rights. If a party disobeys a court’s payment order, the court may enter additional orders against the non-paying party, but can’t stop the bank from exercising its rights. Small consolation for the spouse who faces the loss of the house.
So once you’re in, how do you get out? Unless you file for bankruptcy protection, there is only way: getting the bank’s agreement. That means proving to the bank that your co-borrower is ready, willing and able to repay the loan on time and without your help. Or it may mean coming up with a new guarantor or additional collateral. Or making an immediate paydown. Or whatever else all of the parties to the original loan agreement – all of them – agree to.
So before you co-sign a loan, be sure to think it through. Be aware that your potential exposure is for the whole loan, not the loan amount divided by two. And remember that, no matter how your circumstances may change, you can’t undo your original promise to the bank, unless the bank agrees.