Bankruptcy: Loan Co-Signer's Fate Revealed

If you're considering filing for bankruptcy, it's important to understand how it will affect those around you, including any co-signers on your loans. Bankruptcy itself does not affect a co-signer's credit, but if loan payments stop, it will show up on their credit report as non-payment, which can be harmful. When you file for bankruptcy, an automatic stay goes into effect, preventing creditors from taking any action to collect debts from you. However, in the case of Chapter 7 bankruptcy, this automatic stay does not protect co-signers, leaving them vulnerable to creditors. Chapter 13 bankruptcy, on the other hand, offers some protection to co-signers as it is a structured repayment plan, ensuring creditors receive payments.

Chapter 7 bankruptcy

In Chapter 7 bankruptcy, an automatic stay goes into effect, preventing creditors from taking any action against the primary borrower to collect their debts. However, this stay does not protect cosigners, and creditors can legally pursue them for the outstanding balance.

To protect a cosigner during Chapter 7 bankruptcy, one option is to reaffirm the debt. This means that the primary borrower remains personally liable for the debt even after the bankruptcy case is closed. Another option is to discharge the cosigned debt and continue paying it voluntarily, which creates no legal obligation but allows for postponing payment if needed.

It is important to note that the impact of Chapter 7 bankruptcy on a cosigner's credit score and financial stability can be significant. Therefore, communication between borrowers and cosigners before declaring bankruptcy is crucial, ensuring full awareness of potential consequences.

Chapter 13 bankruptcy

When a borrower doesn't have a solid credit history or sufficient income, lenders often require a cosigner—someone who agrees to be responsible for the loan if the borrower defaults. This person is also known as a codebtor. If the borrower files for bankruptcy, the cosigner may be left "on the hook" for the remaining balance of the loan.

Creditors can ask the court to lift the codebtor stay if:

• The cosigner received the benefit of the loan
• The debtor doesn't propose to pay the cosigned debt through the repayment plan
• The creditor will suffer irreparable harm if the stay is not lifted

If the case is dismissed without completing the Chapter 13 plan, both the regular automatic stay and the codebtor stay will be lifted, and the creditor will be free to seek payment from either the debtor, the cosigner, or both.

It's important to note that not everyone qualifies for Chapter 13 bankruptcy, and it's recommended to seek legal advice before proceeding.

Cosigner liability

When an individual with a cosigned loan files for bankruptcy, the cosigner is still liable for the loan and will be pursued by creditors. The cosigner is liable for the full amount of the loan, and the creditor can seek repayment from them. The cosigner's liability remains even after the borrower's bankruptcy discharge, and they may be pursued by creditors for the outstanding balance.

The impact on the cosigner depends on the type of bankruptcy filed by the borrower. If the borrower files for Chapter 7 bankruptcy, the cosigner won't receive any protection from creditors. An automatic stay goes into effect, stopping creditors from taking action against the borrower, but this stay does not extend to the cosigner. As a result, creditors can pursue the cosigner for repayment during and after the bankruptcy process.

On the other hand, if the borrower files for Chapter 13 bankruptcy, the automatic stay also protects the cosigner, preventing creditors from seeking repayment from them. In this case, the cosigner is only liable for the unpaid balance, if any, once the Chapter 13 repayment plan is completed. However, not everyone qualifies for Chapter 13, and there may be circumstances where the bankruptcy judge lifts the stay regarding the cosigner.

To protect the cosigner, the borrower can continue paying the debt until it is paid off. In some cases, such as with an automobile loan, the lender may allow the borrower to continue making monthly payments. Another option is to reaffirm the debt, which means the borrower remains personally liable for it even after the bankruptcy case is closed. However, reaffirming debts may not be advisable unless the borrower intends to keep the item or protect the cosigner.

Protecting cosigners

If you have a cosigner on your debts, your decision to file for bankruptcy will affect them. Here are some ways to protect your cosigners:

Chapter 13 bankruptcy

If you file for Chapter 13 bankruptcy, an automatic stay goes into effect, protecting cosigners from creditors collecting on consumer (non-business) debts. This is called the Chapter 13 codebtor stay. Your creditors can still ask the court to lift the automatic stay under the following circumstances:

• Your cosigner or guarantor received the consideration.
• You don't pay off the debt through your repayment plan.
• The creditor will suffer irreparable harm if the stay is not lifted.

Reaffirm the debt

Another option is to reaffirm the debt, which means you remain personally liable after the bankruptcy case is over. This option is not usually advised unless you need a particular item or want to help protect cosigners and guarantors from creditors.

Continue paying the debt

You can also protect your cosigners by continuing to pay the debt until it's paid off. In many cases, such as with an automobile, the lender will allow you to continue making the monthly payment. However, a lender might not be willing to informally accept monthly payments if a guarantor were in place and had sufficient assets to pay the debt in full.

Reaffirming debt

If you have a cosigner on a loan and you file for bankruptcy, this will affect your cosigner. The cosigner is liable for the full amount of the loan, and the creditor can seek repayment from them. An exception to this is if you file for Chapter 13 bankruptcy, in which case, an automatic stay goes into effect that stops creditors from taking any action to collect their debts from either you or your cosigner.

If you file for Chapter 7 bankruptcy, your cosigner won't be protected from creditors. However, there are ways to protect your cosigner, such as reaffirming the debt.

Reaffirmation provides a way to keep collateral as long as you abide by the new terms set out in the reaffirmation agreement and continue to make payments. You can also negotiate new terms to reduce your payments, interest rate, or the total amount you will have to pay over time. However, the lender does not have to agree to new terms, and most reaffirmation agreements are on the original contract terms.

Reaffirmation agreements are rejected if it appears that you can't afford the payments after covering your basic living expenses or if you owe much more on the debt than the property is worth.

Reaffirming a debt is a big decision as it leaves you personally liable for the debt, and you can't walk away from it after bankruptcy. You'll still be legally bound to pay the balance even if the property is damaged or destroyed. Additionally, you'll have to wait eight years before filing another Chapter 7 bankruptcy case.

Frequently asked questions