If I File Bankruptcy Will It Affect My Cosigner?

When an individual cosigns a loan, they become a co-borrower, legally binding themselves to the debt and pledging their financial credibility to help the primary borrower secure financing they might not otherwise qualify for. Bankruptcy, conversely, is a legal process designed to help individuals or businesses eliminate or repay their debts under the protection of the federal court system. It offers a structured pathway for debtors to gain a fresh financial start.

A common question for many considering bankruptcy is how this legal action will impact a person who has cosigned a loan for them. This article explores the specific ways a debtor’s bankruptcy filing can affect their cosigner, detailing the legal principles and practical consequences involved. Understanding these dynamics is important for both debtors and cosigners.

How Bankruptcy Affects Cosigners

When someone cosigns a loan, they enter into an agreement of joint and several liability with the primary borrower. This legal principle establishes that each party is individually responsible for the entire debt, not just a portion of it. Should the primary borrower default on payments, the lender has the right to pursue the cosigner for the full outstanding balance.

A bankruptcy filing by the primary borrower generally discharges their personal liability for the debt, meaning they are no longer legally obligated to repay it. However, this discharge typically does not extend to the cosigner. The debt remains, and the lender retains the right to collect the full amount from the cosigner. Once the primary borrower’s debt is discharged, the lender will often direct their collection efforts toward the cosigner.

This shift in responsibility can lead to immediate and significant financial repercussions for the cosigner. The cosigner becomes solely responsible for the remaining balance, including any accrued interest and fees. Furthermore, if the lender reports missed payments or defaults to credit bureaus, the cosigner’s credit score can be negatively affected. This impact can make it more challenging for the cosigner to obtain new credit or favorable interest rates in the future.

Impact Based on Debt Type and Bankruptcy Chapter

The effect of a debtor’s bankruptcy on a cosigner can differ based on the type of debt involved and the specific chapter of bankruptcy filed. Unsecured debts, such as personal loans, credit cards, or medical bills, are not backed by collateral. When the primary debtor’s liability for these debts is discharged in bankruptcy, the cosigner becomes fully responsible for the entire remaining balance.

Secured debts, like car loans or mortgages, are backed by specific property, known as collateral. In bankruptcy, a debtor with secured debt has several options: reaffirmation, redemption, or surrender. Reaffirmation involves the debtor agreeing to continue making payments on the debt and remain personally liable, effectively waiving the bankruptcy discharge for that specific obligation. If the debtor reaffirms the debt and consistently makes payments, the lender may not immediately pursue the cosigner, but the cosigner remains liable if the debtor defaults at a later date.

Alternatively, a debtor may choose to surrender the collateral to the lender. The debt is then discharged, and the primary borrower is generally no longer liable for any deficiency balance after the collateral is sold. In this scenario, the cosigner typically becomes responsible for any remaining deficiency balance that the sale of the collateral does not cover. Another option is redemption, where the debtor pays the lender the current market value of the collateral in a lump sum. If the debtor redeems the property, the cosigner’s liability is typically eliminated.

The bankruptcy chapter chosen also plays a significant role in how a cosigner is affected. In a Chapter 7 bankruptcy, which involves the liquidation of non-exempt assets to pay creditors, the primary debtor receives a discharge of most debts. However, the automatic stay, which temporarily halts collection efforts, generally protects only the debtor. There is typically no co-debtor stay in Chapter 7 cases for consumer debts, meaning creditors can pursue the cosigner almost immediately after the debtor files or receives a discharge.

Conversely, Chapter 13 bankruptcy, a reorganization bankruptcy, offers a specific protection for cosigners known as the co-debtor stay. Under Section 1301, creditors are temporarily prevented from collecting consumer debts from a cosigner while the primary debtor is making payments under a Chapter 13 plan. This stay applies as long as the debtor is adhering to the plan and the debt is included within it. The co-debtor stay is temporary and only applies to consumer debts, not business debts or certain tax debts. It lifts if the debtor’s plan fails, or upon the debtor’s discharge, at which point the cosigner could be pursued for any remaining balance not covered by the plan payments. A well-structured Chapter 13 plan can potentially pay down the cosigned debt, which can significantly reduce the cosigner’s ultimate financial obligation.

Options for Cosigners

When a primary borrower files for bankruptcy, and the cosigner becomes responsible for the debt, several options may be available. A cosigner facing demands for payment can contact the lender directly. Lenders may be open to negotiating a new payment plan, a reduced settlement amount, or other arrangements to avoid further legal action. Creditors often prefer to work with the cosigner to recover a portion of the debt rather than pursuing litigation.

Another option for the cosigner is to pay the debt in full. As they are jointly and severally liable, this resolves the debt and prevents further collection efforts or damage to their credit. While this can be a financial burden, it ensures the debt is satisfied according to the original agreement.

If the cosigned debt is substantial and the cosigner’s financial situation makes repayment impossible, they might consider exploring their own bankruptcy options. This decision should not be taken lightly and requires a thorough evaluation of their financial circumstances. Filing for personal bankruptcy could provide a fresh start for the cosigner, but it also carries its own set of consequences, including an impact on their credit history.

Cosigners should monitor the primary debtor’s bankruptcy case, especially if it is a Chapter 13 filing. Understanding the status of the bankruptcy proceedings, including plan payments and the duration of any co-debtor stay, provides insight into their liability. Staying informed allows the cosigner to anticipate when they might be pursued and to prepare accordingly.

Debtor Considerations Before Filing

Before filing for bankruptcy, a debtor with cosigned debts should consider how to mitigate the impact on their cosigner. Open and honest communication with the cosigner is crucial. Discussing the potential consequences of bankruptcy and exploring available options together can help manage expectations and reduce stress for both parties.

While bankruptcy may be necessary, exploring alternatives is a priority if protecting the cosigner. Options such as debt consolidation, debt management plans, or negotiating directly with creditors for revised payment terms can be viable. These alternatives, if feasible, can help the primary borrower avoid bankruptcy, preventing any direct impact on the cosigner.

Consulting with a qualified bankruptcy attorney is important. An attorney can provide an analysis of the debtor’s financial situation, explaining how different types of debt and various bankruptcy chapters will affect cosigners. They can offer advice on the appropriate course of action to achieve debt relief while minimizing adverse effects on those who have cosigned. This legal guidance ensures the debtor understands implications before making a final decision.

Debtors should identify and list all debts that have a cosigner during the bankruptcy planning process. Providing an accurate list ensures these obligations are properly addressed within the bankruptcy petition. This step allows the attorney to develop a strategy that considers the cosigner’s position, incorporating these debts into the bankruptcy plan in a way that offers protection.