Having a cosigner on a loan is a common occurrence for borrowers making a big purchase. But how does bankruptcy affect cosigners? Cosigners could be at risk for paying back a loan if the borrower declares bankruptcy. There are, however, many factors at stake. If you’re cosigning a loan, understand how bankruptcy can affect cosigners.
What Is a Cosigner?
Before understanding how bankruptcy affects cosigners, it’s necessary to understand what a cosigner is and when one is required. A cosigner is often required when a lender is not certain of a borrower’s ability to repay a loan or debt. Purchasing anything relatively expensive, from a vehicle to a home to equipment to furniture, could require a cosigner. In some cases, landlords require that renters have a cosigner to guarantee rent payments. A cosigner may be required if you . . .
- Have no or limited credit history
- Have poor credit or have recently filed for bankruptcy
- Do not have a high enough income to more easily pay off the loan
- Do not have collateral needed to secure the loan
If any of the above apply, it’s common for lenders to ask for a cosigner. Once someone with higher income and better credit agrees to cosign your loan, they’re responsible for paying off the debt if you’re unable to do so. A cosigner potentially puts their credit and financial stability on the line after signing. Therefore, it’s important for cosigners to understand how they’re affected by a borrower’s bankruptcy.
Differences for Cosigners in Chapter 7 and Chapter 13 Bankruptcy
Bankruptcy can affect cosigners in different ways. While bankruptcy is a financial tool designed to restructure and eliminate debt burden, it doesn’t always leave cosigners off the hook. Understanding the different chapters of bankruptcy is essential, and there are significant differences between Chapter 7 and Chapter 13 bankruptcy.
Chapter 7 Bankruptcy and Cosigners
While bankruptcy is designed to discharge and eliminate debt, cosigners are still responsible in some cases. Chapter 7 bankruptcy, for example, is a common type of bankruptcy that involves quickly liquidating unsecured debt, meaning debt that’s not backed by collateral or assets. Credit card debt, medical bills, and personal loans are all examples of debt that could be eliminated through Chapter 7 bankruptcy.
One important thing to note about Chapter 7 bankruptcy and cosigners is that anyone who cosigned your loan will still be responsible for paying the debt even if you declare bankruptcy. Why? Because, in this case, cosigners are not protected by the automatic stay.
When you file for bankruptcy, the automatic stay takes effect. The automatic stay is a provision that immediately halts all collection efforts and any repossessions of your property. It also bars creditors from contacting you about your debt. While the automatic stay is a powerful and legally backed provision, its protections do not apply to cosigners:
- Your debt discharge will not eliminate a cosigner’s repayment responsibilities.
- Creditors and collectors are free to pursue the cosigner to fulfill debt payments.
- Even after your debt is discharged by Chapter 7 bankruptcy, creditors can pursue cosigners to repay the debt.
- If your Chapter 7 bankruptcy case involves asset liquidation, creditors can pursue your cosigners and their assets to satisfy repayment.
Even though Chapter 7 provides a relatively fast and streamlined means of eliminating debt, it can be especially harsh for cosigners who find themselves responsible for a borrower’s debt burden.
Chapter 13 Bankruptcy and Cosigners
Chapter 13 bankruptcy is an equally common type of bankruptcy that involves consolidating debt and making repayments over three to five years, typically. Chapter 13 bankruptcy is more commonly reserved for individuals with a steady income but who also carry significant debt and need to protect their assets.
One of the main differences for cosigners under Chapter 13 bankruptcy, as opposed to Chapter 7, is that cosigners are protected by the automatic stay during Chapter 13 bankruptcy. If a debtor is paying off the debt as part of a Chapter 13 bankruptcy repayment plan, the codebtor stay goes into effect. This action extends the same automatic stay protections to cosigners.
Under the codebtor stay, creditors can’t pursue cosigners to collect on a debt. There are some exceptions, however, if circumstances change. The codebtor stay could be invalidated and the stay lifted for various reasons, such as if:
- The Chapter 13 repayment plan will not pay off the cosigned debt in full
- Your Chapter 13 bankruptcy case is converted to a Chapter 7 bankruptcy case
- There is evidence that the debtor acted in bad faith and does not intend to actually pay the debt
Overturning a codebtor stay is not merely a simple request, however. It requires significant legal consideration and making a case in court for doing so.
How Bankruptcy Can Affect the Cosigner’s Credit Score
It’s important to understand how bankruptcy can affect the cosigner’s credit score. There are many bankruptcy myths surrounding credit scores, so be sure to know the facts. If a borrower declares bankruptcy, the cosigner’s credit score won’t necessarily be affected. The bankruptcy filing is independent of the cosigner’s credit.
However, loan payments must still be made. If the loan payments stop after the borrower files for bankruptcy (or at any other time), the cosigner’s credit will be negatively affected. If the cosigner, or the borrower, continues to pay the debt, the cosigner’s credit will be unaffected.
Be an Informed Cosigner
If you’re cosigning a loan for a friend or family member, it’s important to understand how bankruptcy affects cosigners. If the borrower is at risk for declaring bankruptcy, realize that you could be responsible for paying off the remaining amount.
What seems like a simple cosigner agreement can become very complicated if a bankruptcy filing occurs. If you need guidance, speak with our experienced Ohio bankruptcy attorneys. If you are facing overwhelming debt or loans that you cannot repay, our bankruptcy lawyers can go over all of your debt relief options with you. Give us a call at 614-228-4435 (Columbus), 937-222-7472 (Dayton), or 877-654-5297 (Cincinnati).
