The Danger in Co-Signing or Guaranteeing Loans

(Or, I Never Benefited So Why Should I Have to Pay?)

The client sat across the desk with a look of despair. He had just been served with a summons naming him as a Defendant in a law suit. He had no idea what the suit was about. He merely knew that someone was suing him for $10,000.00. When we examined the supporting documentation, the story became clear. The client had signed a promissory note as a co-maker for a fellow worker at his office. He hardly remembered the co-worker who left the company two years earlier. He had forgotten that day when his “friend” stopped by his desk and asked for some help in qualifying for his new car loan. It didn’t seem like a big deal, and being a kindhearted guy, my client happily acted in the capacity of co-maker.

You can guess the rest of the story. The co-worker moved to another state, lost his job and stopped paying on the car loan. By the time the car was repossessed it was all banged up and worth only a small fraction of the amount due on the loan. So guess who the finance company was coming after?

Too often we see situations in which people take the act of being a co-maker or guarantor too lightly. It is a very serious and potentially dangerous commitment. When you sign as a co-maker, you are promising the lender that you personally will pay the money back without regard to the ability of the primary maker. You can find yourself in the position of paying back someone else’s loan. You never saw the money, you never benefitted from the loan, you probably never even got to ride in the car that was financed, but you have to pay for it now.

A guarantee can put you virtually in the same position as being a co-maker. If the primary party defaults, you have guaranteed the lender that you will make the loan good. Therefore, for example, if the maker goes bankrupt guess who has to pay? The situation can even be worse in the case of a line of credit. You may have signed as a guarantor for a line of credit for a friend, a family member, or even for your employer or for the company in which you have an interest. We have had clients who never gave a second thought to giving their bank the requested guarantee on their corporation’s line of credit when times were good. The line of credit may have been up to, for example, $1,000,000.00 even though the company was only using $100,000.00 at the time. The officer may have forgotten that he gave his personal guarantee. Over the years, the company may have drawn deeper and deeper into the line of credit to finance expansion, or other activities. Unfortunately, as the economy worsened and corporations were forced into bankruptcy, many individual officers and directors were also forced into personal bankruptcy solely because of their personal guarantees. To their surprise they found that they were personally liable for up to millions of dollars.

This is not to say that guarantees should never be given. You may wish to assist children in purchasing and financing homes and businesses and you will be willing to give your guarantee. You will probably find that the only way a lender will provide a line of credit to your business is to have your personal guarantee (including your spouse’s guarantee). We make decisions and take business risks every day to advance our interests. It is vital to make those decisions fully understanding the potential consequences and assuming the worst. If you end up being personally liable you don’t want it to be for a loan you don’t remember to a person you haven’t seen or heard from in years. If a co-worker asks you to “do him a small favor” and co-sign his car loan, give him a copy of this article and tell him no.