Learn how this Good Deed could Mess with your Plans…
When we die our executors have a number of obligations in the administration of our estates, including the repayment of any debts owed at that time. But what about debts that you may have guaranteed for family members? Providing guarantees during your lifetime can have unintended consequences when you die.
What does it mean when I Guarantee or Co-sign a Loan?
Generally, a guarantee is a contractual obligation undertaken by a person or entity called the guarantor. Under a guarantee, the guarantor promises that they will fulfill another person’s debt or obligation in the case of default. A lender will usually demand payment from the borrower before going after a guarantor.
On the other hand, when a person co-signs a loan, they and the borrower agree to be jointly responsible for the debt. Each of the co-signer and the borrower is independently responsible for the loan. If the borrower doesn’t pay, a lender can demand payment from the co-signor before or instead of first demanding payment from the borrower.
Guaranteeing and Co-signing in the Family Context
These days, it is common for family members to co-sign or guarantee loans for other family members. The most common scenario involves children turning to their parents for financial assistance in securing a loan. Younger individuals often do not have the required income to satisfy the lender. Thus, financial institutions often require a guarantor or co-signor, which typically ends up being a parent.
As mentioned, a guarantee places an immediate financial burden on the guarantor (the parent, in this scenario). In the family scenario, that means if your child defaults on their loan, you will be responsible for the monthly payments (or even the full amount of the loan). Similarly, parents who co-sign loans are “joint debtors” with their children. Both guaranteeing and co-signing can mean that your own land and assets are at risk, should your child not make their payments. Another often-overlooked implication is that your obligations as guarantor/co-signor do not end when you die. Instead, these obligations are passed along to your estate, and your estate remains liable on your child’s loan.
A lender’s priority is getting paid, and they will use any avenue they can to collect. Becoming a guarantor or co-signer creates a direct link to your assets, even after you have died. Your child’s creditor now becomes your creditor too. This means that your executor must pay your creditors before any of your assets can be distributed to your beneficiaries. So, if your child cannot pay a loan that you have guaranteed or co-signed, that creditor could attempt to seek payment through your estate. Subsequently, your children may not receive the proceeds of your estate as you intended.
Co-signing a Mortgage
Another common way for parents to aid their children is by co-signing a mortgage. In these cases the banks will often require that the parents be added to title as 1% owners, with the children owning 99%. The issue in the estate planning context is that your 1% ownership belongs to your estate when you die. If you have more than one child, and your Will divides your estate equally among all of your children, then your 1% interest in the property will be divided equally among all of your children (i.e. your child that owns 99% does not automatically receive your 1% interest in their property when you die). This issue can be navigated in scenarios where all of your children get along, but it can create havoc where one or more of your children refuse to give up their interest in your other child’s property.
What can I do?
In the scenario mentioned above, a remedy can be found in smart estate planning. For example, you can address that sneaky 1% in your Will by leaving your 1% interest to the child holding the remaining 99%.
Generally, when guaranteeing or co-signing a loan for your child, always consider the implication on your assets and estate. Sometimes that involves talking with your lawyer or asking tough questions like:
- Will your child realistically be able to afford the payments?
- Are you overextending yourself by co-signing or guaranteeing the loan?
- Will this become a point of contention between you and your child(ren)?
- Will this influence how you should set up or distribute your estate?
In today’s economic climate, it is understandable that you want to help your children by helping them with loans. However, having your estate distributed the way you intend can also be a large part of accomplishing that goal. Our estate lawyers are here to help you navigate through these issues, and more.