Cosigner

A cosigner is a person who becomes liable for someone else's credit obligation without receiving value in exchange for doing so. The Federal Trade Commission's Credit Practices Rule defines the term at 16 CFR 444.1(k) as "a natural person who renders himself or herself liable for the obligation of another person without compensation", and expands it to include "any person whose signature is requested as a condition to granting credit to another person, or as a condition for forbearance on collection of another person's obligation that is in default". It excludes a spouse whose signature is required only to perfect a security interest under state law, and it adds the sentence that decides most arguments: "A person is a cosigner within the meaning of this definition whether or not he or she is designated as such on a credit obligation."

A second federal definition, at 15 USC 1650(a)(1) for private education loans, says the same thing in nearly the same words, reaching any individual liable for another's obligation without compensation "regardless of how designated in the contract or instrument". Two separate federal definitions treating the label as irrelevant is worth noticing, because a document that says "guarantor" or "additional party" or nothing at all can still be a cosigner arrangement. The published material on authorized users draws the line between the three roles a person can occupy on someone else's account.

The notice is the heart of this subject, and it is quotable because the regulation prescribes its words. 16 CFR 444.3(a) makes it a deceptive practice for a lender or retail installment seller "to misrepresent the nature or extent of cosigner liability to any person", and an unfair practice "to obligate a cosigner unless the cosigner is informed prior to becoming obligated ... of the nature of his or her liability as cosigner". Paragraph (b) then gives a safe harbor: a creditor that complies with (c) does not violate (a). And (c) requires "a disclosure, consisting of a separate document that shall contain the following statement and no other", given before the cosigner becomes obligated, which for open-end credit means before the agreement creating liability for future charges is executed. The statement reads, in part:

"You are being asked to guarantee this debt. Think carefully before you do. If the borrower doesn't pay the debt, you will have to. Be sure you can afford to pay if you have to, and that you want to accept this responsibility."

"You may have to pay up to the full amount of the debt if the borrower does not pay. You may also have to pay late fees or collection costs, which increase this amount."

"The creditor can collect this debt from you without first trying to collect from the borrower. The creditor can use the same collection methods against you that can be used against the borrower, such as suing you, garnishing your wages, etc. If this debt is ever in default, that fact may become a part of your credit record."

The third paragraph is the one people are surprised by, and it is the reason the common description of a cosigner as a last resort for the lender is unreliable. The notice also ends by saying "This notice is not the contract that makes you liable for the debt", so receiving it settles nothing about what the contract says. Read the contract as well.

What the rule's own scope is, stated as what the regulation contains. 16 CFR 444.1(a) and (b) define "lender" and "retail installment seller" as persons engaged in those businesses "within the jurisdiction of the Federal Trade Commission". So the Credit Practices Rule's requirements are addressed to creditors within that jurisdiction, and 16 CFR 444.5 additionally allows the Commission, on a state agency's application, to switch off a provision in a state whose own requirement affords protection "substantially equivalent to, or greater than" the rule's. If you are cosigning and no notice appears, the useful question is what the contract makes you liable for, not which agency's rule should have produced a form.

A separate statute limits who a creditor may ask for. The Equal Credit Opportunity Act's Regulation B provides at 12 CFR 1002.7(d)(1) that a creditor "shall not require the signature of an applicant's spouse or other person, other than a joint applicant, on any credit instrument if the applicant qualifies under the creditor's standards of creditworthiness for the amount and terms of the credit requested". Paragraph (d)(5) then allows the request where it is genuinely needed: if the personal liability of an additional party is necessary to support the credit requested, "a creditor may request a cosigner, guarantor, endorser, or similar party", and the applicant's spouse may serve, "but the creditor shall not require that the spouse be the additional party". And (d)(6) bars a creditor from imposing on an additional party any requirement it could not impose on the applicant. Narrow exceptions in (d)(2) through (d)(4) let a creditor require another person's signature on the specific instrument needed to reach jointly held property, community property or pledged collateral.

Put together, the rule is not that a creditor may never ask for a cosigner. It is that it may not ask when the applicant already qualifies, may not insist the additional party be the applicant's spouse, and may not hold the additional party to a standard it would not apply to the applicant.

What sits outside this page. Joint liability from the first day, cosigner release programs, and the statutory protections when a cosigner dies or files bankruptcy on a private education loan are covered by the published material on private student loans. The route for a card applicant under 21 belongs to the material on credit limits. And a guarantor is a related but distinct role whose liability depends on the terms of the guaranty and on state contract law, which is why nothing here states a general rule about it.

The borrower applies and does not qualify alone, or qualifies only on worse terms. The creditor asks for an additional party. Before that person becomes obligated they should receive the separate Notice to Cosigner, and then they sign the credit agreement itself, which is what creates the liability. From that point the obligation is theirs as well as the borrower's, it appears on their credit report, and it counts among their obligations when they apply for credit of their own.

A hypothetical example of the exposure. Nadia cosigns her nephew's $22,000 car loan, 60 months at 6.5 percent, a payment of about $430.46 a month.

He pays for 18 months and then stops. He has paid about $7,748 in total (18 × $430.46), of which roughly $1,879 went to interest. So only about $5,869 of the original balance has been retired and roughly $16,131 is still outstanding: eighteen of sixty payments has cleared a little over a quarter of the principal.

The creditor's demand on Nadia is that outstanding balance, plus interest, plus any late fees and collection costs, exactly as the notice she signed said. It does not have to sue her nephew first, or repossess first, or show that it tried. And for the whole of those 18 months the loan was already on her credit report, and its $430.46 payment was already counted among her obligations by any lender she applied to.

Pros

• It is often the only route to approval for a borrower with no credit file, and the published material on credit history explains why a thin file is a distinct problem from a poor one.
• The rate offered usually reflects the cosigner's credit rather than the borrower's, which can make a material difference to total cost.
• The mandated notice is a genuinely informative document, in plain words, and must be given before the obligation is taken on.
• Regulation B bars a creditor from asking at all where the applicant qualifies alone, and bars it from insisting the additional party be a spouse.
• Payments reported on the account build the borrower's credit history from the start.

Cons

• The creditor can collect from the cosigner without first pursuing the borrower, which the notice states in terms.
• Liability includes late fees and collection costs, so the exposure can exceed the amount originally borrowed.
• The debt appears on the cosigner's credit report and counts against them when they apply for credit of their own, from day one and whether or not anything goes wrong.
• Getting off the obligation is not a right. Release, where it exists at all, is a contractual program the lender may decline.
• The label does not control, so someone can be a cosigner on the substance of what they signed without the document using the word.
• The mechanism sits inside a family relationship, which is where the real cost of a default usually lands.