Co-Signing or Guaranteeing a Loan

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People often co-sign or guarantee a loan for a friend or relative without knowing what can happen. If they knew, they might not do so. This script explains:

• the difference between co-signing and guaranteeing a loan.
• the different types of guarantees.
• the legal result of co-signing or guaranteeing a loan.

Guaranteeing and co-signing a loan are often similar

Often, if you guarantee a loan for someone who borrows money (called the debtor), the party lending the money (called the lender or creditor) must first demand payment from the debtor, before going after you, the guarantor. But if you co-sign a loan, you are just as responsible to pay the loan back as the debtor is. So the lender or creditor can demand payment from you before, or even instead of, demanding payment from the debtor. It’s important that you review the guarantee or co-signing documents carefully before signing. These documents are often similar. As a result, guaranteeing a loan often has similar obligations and responsibilities as co-signing a loan.

Different types of guarantees

They include:

• a specific or limited guarantee
• a continuing guarantee
• an all accounts guarantee

Before you sign a guarantee, find out what type of guarantee it is. A guarantee document may have one or more of these guarantee types.

What is a “specific guarantee” or “limited guarantee”?

A specific or limited guarantee means you agree to pay (or be liable for) a certain amount for a specific thing. For example, if you guarantee a car loan for a fixed amount of $10,000, you are responsible to pay the car loan of $10,000. Or if you decide to guarantee your child’s purchase of a business, the lending seller or bank may ask you to guarantee a specific amount of the debt or limit your guarantee to a certain figure.

What is a “continuing guarantee”?

A continuing guarantee means you agree to pay a particular type of loan as long as the guarantee lasts. For example, you guarantee the operating line of credit for your spouse’s business. The line of credit may be at zero or at the maximum amount. It usually goes up and down with the cash flow and profitability of the business. But you’re responsible for everything owing until the guarantee ends and the entire debt is paid.

What is an “all accounts guarantee”?

An all accounts guarantee means you agree to pay any amounts the debtor owes to the lender or creditor, including amounts that you may not know about. The loan, or a line of credit agreement, may allow the debtor to borrow more, and you may be liable for any extra amounts too. You may also become liable for things called “contingent liabilities,” such as costs of the lender or creditor to collect the debt. This may include the full amount of any reasonable legal and other fees. Lending companies use this type of loan or credit agreement most often.

What can happen if you co-sign a loan?

If your son borrows money from a bank to buy a car and you co-sign his loan, things are fine as long as he makes all his payments on time. But if he can't make a loan payment, the bank can “garnish” (or take money from) your bank account before you know anything about it.

For more information on garnishment, check script 251 on “Garnishment”.

What can happen if you guarantee a loan?

In this car example, if you guarantee the loan instead of co-signing it, you may still have to pay the full amount. But usually the bank has to first demand payment from your son before getting it from you.

What if you or the borrower pledges something for the loan?

Say your son used (or pledged) the car he’s buying as security for his car loan, with a security agreement. If he can’t make a loan payment, the bank can seize the car. If the bank does that, you’re not responsible for anything more. The bank can’t sue after seizing the car, even if the car is worth less than the amount of the loan still owing. But if you pledged something as security for the loan, the bank can seize what you pledged, instead of going after your son or seizing what he pledged.

Be careful with acceleration clauses

Most loan contracts have an acceleration clause. It lets the lender or creditor demand immediate payment of the whole loan – not just the “arrears” (or missed payments) – if the borrower breaks any part of the agreement. So just one missed payment could mean you have to pay the whole loan immediately.

Be careful about the risk of future borrowing

A major risk if you co-sign or guarantee a loan is that you may be responsible for additional money that the debtor may borrow later. In standard loan forms, a clause makes you responsible for both the loan, and any other amounts the debtor borrows from the same lender or creditor in the future, plus their costs to collect the debt. This is true even though you may not know anything about the debtor borrowing more. So if you co-sign or guarantee a loan, put a ceiling or an upper limit in the loan contract to limit how much you could be responsible for.

Your credit rating could be harmed

Even though the loan is made for the person you are helping, your credit rating may be harmed if the person stops paying the loan. This is usually more common if you are a co-signer, jointly responsible for the debt. Then any default on the debt can immediately harm your credit rating. With a guarantee, because the guarantor generally isn’t liable until repayment has been demanded, your credit rating may be affected only if you don’t repay the debt if the lender or creditor demands it.

You can become a guarantor even though you don’t sign anything

Guaranteeing a loan or other debt doesn’t always need your signature. One example is a secondary credit card, where a second person gets their own card on the primary cardholder’s account. The credit card contract often says that the first time the secondary cardholder uses the card, they are guaranteeing all further debts on the credit card.

Another example involves small business loans. Often the loan agreement says that the person making the agreement for the company is also personally guaranteeing the debt. No separate signature or acknowledgement is required – the one signature you make for your company also binds you personally.

Before you co-sign or guarantee a loan, read the document carefully

Sometimes you want (or have) to co-sign or guarantee a loan. It may be a sound business deal, or it may help a family member. But before you put yourself at risk, look at the situation carefully. Ask questions like:

• Why does the lender or creditor require a co-signer or guarantor?
• How high is the risk that the borrower will have trouble and you’ll have to pay the loan?
• What will happen if you don't sign?
• Most importantly, can you afford to pay off the loan if the borrower can’t?

If you’re not sure about your responsibility, or about anything else in the loan contract, get advice from a lawyer. If you decide to co-sign or guarantee a loan, ask the lender or creditor in writing to keep you informed in writing of all activity on the loan. This can help you see a problem developing and correct it before it’s too late. You should also insist on a copy of every document you sign.

What should you do when the loan is paid off?

Make sure you are not still liable after the original loan is repaid. Insist that the lender or creditor return the original guarantee or loan document to you after the loan is repaid. You should also get a document clearing you of any liability for the loan or guarantee. That document could be a letter of acknowledgement, a copy of the debtor’s discharge, or a release.

Can you stop being liable before a loan is repaid?

You can always negotiate with the lender or creditor so you are no longer liable for a loan that you guaranteed or co-signed. For example, someone else may be willing to replace you as the guarantor or co-signer. Or the debtor may have repaid most of the loan—enough to satisfy the lender or creditor. Or there may be enough other co-signors or guarantors to satisfy the lender or creditor.

More information

See Consumer Law and Credit/Debt Law published by the Legal Services Society. This manual is for paralegals, legal information counsellors, and lawyers with clients who have consumer or debt problems.

[updated April 2015]

The above was last edited by John Blois.

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