A co-signer guarantees repayment of a loan if the principle borrower defaults. An individual who needs a car loan but who doesn't qualify because of a low credit score, may get the loan with the help of a co-signer with a better credit history. Laws on co-signers vary from state to state, but the general rule is a co-signer is equally liable for payment in full, and just as qualified to become a defendant in a lawsuit.
Federal law requires that a lender provide a co-signer's notice, which will explain that a co-signer is liable for the entire loan balance if the principle borrower defaults; liability is not divided between the two individuals. A lender can bring suit against the co-signer, and is more likely to do so if the co-signer has a better credit score and is in a better financial position. The law of the individual states sets a statute of limitations on written contracts, such as auto loans. The statute of limitations serves as a deadline for the filing of a lawsuit on a loan in default, and it begins running with the last payment made. A co-signer may sue the principle borrower on the loan to force that party to pay half of the amount due.
Credit Scores and Taxes
The lender will report the performance on the loan to credit bureaus, and any late or missed payments will show up on the reports of both the borrower and the co-signer. Federal and state laws on collections apply to both parties. The loan can be assigned to a collection agency, which then has the right to pursue repayment through letters and phone calls, within the limits set down by the Fair Debt Collection Practices Act, a federal law. If a co-signer agrees to settle the debt for less than the full amount, the creditor may report the difference as income to the IRS, and the co-signer would owe taxes on that amount.
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State Protections for Co-Signers
Some states provide additional protections for co-signers. In Michigan, for example, a lender must notify a co-signer that a principle borrower is behind on the loan or in default before reporting the adverse information to the co-signer's credit report or taking any collection actions against the co-signer. The co-signer must have at least 30 days to bring the loan current or make acceptable payment arrangements before the credit bureaus are notified. In some states, if a creditor repossesses a car and then sells it, it may pursue a co-signer for any deficiency -- the difference in the balance of the loan and the sale price. However, the protections under the federal Servicemembers Civil Relief Act of 2003 may apply: if you are called for active military duty, for example, the car may not be repossessed without a court order, and the creditor may not pursue a default judgment if you fail to appear in court to answer a lawsuit.