Proceed with caution if you agree to co-sign a mortgage

Dear Rick:

My wife and I have a dispute that I hope you can help us with. My wife’s sister, who I think is irresponsible and has no idea how to handle money, asked us to co-sign a mortgage. She cannot get a mortgage on her own because of her financial background.

My wife thinks buying a house would be good for her sister, but I don’t particularly like the idea. What is the worst case scenario if she does not repay her loan? My wife says the worst that can happen is she loses the house. Is this true, and if not, can something else happen to us?

J.B.

Dear JB:

Unfortunately, if your sister-in-law defaults on the loan and you are the co-signer, the worst is not that she loses the house but rather, the worst is that you may be liable for the loan balance. Also, if they foreclose on the house, you may be personally liable for the difference between the selling price of the house and the outstanding mortgage.

For example, if the outstanding loan balance was $150,000 and the house was foreclosed and sold for $100,000 in foreclosure proceedings, you could be personally responsible for the additional $50,000 ($150,000 loan – $100,000 sale proceeds). In addition, your credit rating may also suffer because you were a co-signer on a defaulted mortgage.

If you were held liable by the bank, you would potentially have a lawsuit against your sister-in-law, however, we all know how messy and uncomfortable that can be. Also, if your sister-in-law chooses to file for bankruptcy, her obligation to you would be discharged and you would have no recourse against her.

Ultimately, each time you co-sign a loan, you must acknowledge that you may be liable for the entire loan balance in the event of default.

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I am often asked to co-sign loans for friends and relatives. I always advise people to proceed with caution. Co-signing a loan is like lending someone money. When it comes to lending money from family or a friend, I always recommend that if you expect to be repaid, you should treat it as a business transaction. In other words, terms such as interest, when payments are due and what happens in the event of default, should be discussed and put in writing. I think the same thing applies when you co-sign a loan for someone. This is a legal liability, so you should take it seriously.

I recognize that when it comes to family and friends, money is not the most important issue. However, let’s not forget that most divorces and family disputes revolve around money. Therefore, you cannot simply discount the financial ramifications when co-signing a loan.

All in all, I would discourage most people from co-signing a loan, especially a long-term mortgage, because if the bank wouldn’t lend them money, why would you?

Good luck.

Rick Bloom is a paid financial advisor. His website is www.bloomadvisors.com. If you’d like him to answer your questions, email [email protected]

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