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What to do when the loan you co-signed defaults

There's a reason a lender asked for a co-signer -- and now you are being asked to step up and pay. Know what your options are.

By Feb 19, 2014 12:19PM

This post comes from AJ Smith at partner site on MSN MoneyWhether you co-signed a student loan for your child, a car lease for your father or a mortgage for a friend, you are now responsible for that debt. Unfortunately, if the borrower is not able or willing to pay back the loan, you must step up or face the consequences. Here are some steps to take if the loan defaults.

1. Ask for mercy

You need to determine whether the lender is willing to negotiate on terms. Sometimes if there is a temporary reason you or the borrower can’t pay, the lender may be willing to give you a few months to get back on track. You won’t know if you don’t ask.

Business man with open hand out © Le Club Symphonie, Cultura, Getty ImagesExplain your circumstances. Tell the creditor that you want to pay off the loan but you aren’t able to now. This conversation might lead to a reprieve of a few months where you don’t have to pay or it could lead to smaller payments over a longer time. Be open to options and let the lender know you are trying to make it work.

2. Refinance

Refinancing the loan can allow you to make smaller monthly payments, but the sooner you ask, the better. If you are way behind on payments, you may not be able to get a good interest rate or even a new loan at all. When refinancing, you could try having the primary borrower do this on his or her own. There is a chance that if the loan has been paid down significantly, they may qualify without you co-signing. This means you are no longer responsible at all for the loan.

On the other hand, you could also refinance by yourself. If your credit is much better than that of the borrower, You may get a better interest rate this way, but you will be solely responsible for the debt (though you are just as equally liable if the primary borrower doesn't pay). Of course, if it is for a car or home, you can take possession of the item and sell it to pay the loan back. This isn’t always a great option if the point of co-signing was to help your friend or relative have someplace to live. But if it comes down to it, you have the option.

3. Strike a deal

Try working with the borrower to make the situation better for everyone. You can offer to pay part of the payments each month or all of the payments for a few months until they can take over. You can even set it up so a portion of the borrower’s paycheck goes straight into your bank account.

Tips for next time

You may be scoffing at the thought of a "next time" but it’s good to be prepared just in case.

There are some things you can do upfront, before you co-sign to protect yourself. Try negotiating the terms. For example, see if you can get it in writing that you are responsible for the principal only and won’t have to pay any late charges or fees in the event of a default. Also, request that the lender notify you of any missed or late payments. Finally, make sure you have copies of all the important documents. Treat this as your loan -- -- your signature is on it, after all.

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