How Will My Impending Bankruptcy Affect My Loan Co-Signers

2/16/2016

Filing for bankruptcy can affect anyone who co-signed a loan with you because a co-signer shares responsibility for repaying the debt. If your obligation is discharged, the co-signer may still be responsible for the remaining balance. The impact can also differ depending on whether you file Chapter 7 or Chapter 13 bankruptcy. Because bankruptcy laws and individual circumstances vary, it is important to understand how filing could affect both you and your co-signer and to speak with a qualified bankruptcy attorney before making a decision.

3 Key Takeaways

1. A co-signer remains responsible for the debt. Co-signing means accepting responsibility for repayment if the primary borrower cannot pay. A borrower's bankruptcy generally does not eliminate the co-signer's obligation to the lender.

2. The type of bankruptcy can make a difference. In the situation discussed in the article, Chapter 7 could leave the co-signer responsible for the car loan, while Chapter 13 may provide different protections while the borrower follows a court-approved repayment plan.

3. Professional guidance is especially important. Bankruptcy can have significant legal and financial consequences for both borrowers and co-signers. A bankruptcy attorney can provide legal advice, while a certified credit counselor can help review the borrower's overall financial situation and available options.

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Filing for bankruptcy can provide relief from certain debts, but what happens when someone else co-signed one of those debts?

If a parent, family member, friend or another person co-signed a loan for you, your bankruptcy may have financial consequences for that person. Understanding those consequences is important before deciding how to proceed.

Bankruptcy laws are complex, and individual circumstances can vary considerably. However, there are some general principles borrowers and co-signers should understand.

What Does It Mean to Co-Sign a Loan?

When someone co-signs a loan, they agree to accept legal responsibility for repaying the debt if the primary borrower does not.

A co-signer isn't simply providing a reference or helping someone qualify for financing. They are taking on a financial obligation.

If the borrower stops making payments, the lender may be able to require the co-signer to make them. Depending on the type of debt and circumstances, the co-signer could potentially be responsible for the remaining balance.

This is one reason co-signing should always be approached carefully. Even when everyone intends for the primary borrower to make every payment, unexpected events such as job loss, illness, divorce or other financial hardship can change the situation.

Does Bankruptcy Eliminate a Co-Signer's Responsibility?

Generally, no. A bankruptcy discharge applies to the person who filed for bankruptcy. It does not automatically eliminate the contractual responsibility of another person who co-signed the debt.

For example, suppose you have a car loan that a family member co-signed. If your personal liability for that debt is discharged through bankruptcy, your co-signer may still be responsible for the debt.

Exactly what happens, however, can depend in part on whether you file Chapter 7 or Chapter 13 bankruptcy.

What Happens to a Co-Signer in Chapter 7 Bankruptcy?

Chapter 7 generally does not provide the same protection for a co-signer that it provides for the person filing bankruptcy.

If your responsibility for a co-signed debt is discharged in Chapter 7, the lender may still seek payment from the co-signer.

Consider a vehicle loan as an example.

If you stop making payments and the vehicle is repossessed, the lender may sell it. If the proceeds from the sale do not cover the outstanding loan balance and permitted costs, there may be a remaining amount known as a deficiency balance.

Depending on the loan agreement and applicable law, the co-signer could potentially be responsible for that remaining balance.

This can create a serious financial burden for someone who co-signed the loan expecting that the primary borrower would repay it.

What Happens to a Co-Signer in Chapter 13 Bankruptcy?

Chapter 13 works differently. Unlike Chapter 7, Chapter 13 generally involves a court-approved repayment plan that typically lasts three to five years.

Chapter 13 also includes a special protection commonly known as the co-debtor stay. For qualifying consumer debts, this stay generally prevents a creditor from attempting to collect the debt from an individual who is also liable with the person filing bankruptcy while the protection remains in effect.

This can provide valuable temporary protection for a co-signer.

However, the co-debtor stay is not absolute. A creditor may ask the bankruptcy court for permission to pursue the co-signer in certain circumstances. For example, this may occur if the Chapter 13 repayment plan does not propose to pay the debt in full.

The protection can also end if the Chapter 13 case is closed, dismissed or converted to another type of bankruptcy.

Because of these limitations, borrowers should not assume that filing Chapter 13 permanently eliminates a co-signer's responsibility.

What If You Want to Keep the Car or Other Property?

Secured debts, such as auto loans, can make the situation more complicated.

If you want to keep property securing a co-signed debt, your options can depend on the type of bankruptcy, your loan, your financial circumstances and applicable bankruptcy law.

If keeping the vehicle or other property is important to you, discuss that goal with a bankruptcy attorney before filing. Your decisions could affect both you and your co-signer.

Can a Bankruptcy Affect the Co-Signer's Credit?

The co-signer's own financial obligation does not disappear simply because the primary borrower files for bankruptcy.

How a particular account or subsequent missed payments affect a co-signer's credit can depend on how the lender reports the account and what happens with the debt.

For that reason, a co-signer should monitor the account and their credit reports rather than assuming the borrower's bankruptcy has resolved the debt.

If you are considering bankruptcy, it is also a good idea to talk with your co-signer about the situation before filing when appropriate. Giving them time to understand the potential consequences can allow them to prepare for the possibility that they may become responsible for payments.

Before Filing Bankruptcy, Understand the Impact on Everyone Involved

If you have co-signed debts, make sure your bankruptcy attorney knows about them.

Ask specifically:

• What could happen to the co-signer under the type of bankruptcy you are considering?
• Could the creditor pursue the co-signer for payment?
• Does a co-debtor stay apply?
• How would the debt be treated in a Chapter 13 repayment plan?
• What happens if secured property, such as a vehicle, is surrendered?
• Could the co-signer become responsible for a deficiency balance?
• Are there alternatives that could reduce the financial impact on the co-signer?

These questions are particularly important when the co-signer is a parent, retired family member or someone else who may have limited income or savings.

Consider Your Options Before Filing

Bankruptcy can provide important financial relief for people facing overwhelming debt, but it is a legal process with consequences that should be carefully considered.

If you're considering bankruptcy, speak with a qualified bankruptcy attorney who can explain how federal and state law applies to your particular situation, including the potential effect on any co-signers.

Before deciding whether bankruptcy is the right option, you may also benefit from reviewing your entire financial situation with a nonprofit credit counselor. A certified counselor can help you examine your income, expenses and debts and discuss potential options for addressing your financial difficulties.

The important thing is to understand your choices before making a decision. If someone else is legally responsible for one of your debts, their financial situation should be part of that conversation too.

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