What is the Potential Impact on a Cosigner if You File a Bankruptcy Petition?
It is fairly common practice, when an applicant doesn’t have sufficient credit history or fails to qualify for a loan, for the lender to extend credit anyway, if a family member or someone else co-signs on a note. What happens, though, when the applicant encounters financial difficulties and chooses to file for bankruptcy protection? What are the implications for the co-signer?
The Effect of Bankruptcy on the Obligations of a Co-Signer
When a debtor files for bankruptcy protection under Chapter 7, there is no protection extended to the co-signer who remains liable to pay the amount due. A Chapter 7 filing will only discharge the obligation of the debtor. The automatic stay of collection efforts does not protect the co-signer from a lawsuit..
There are ways that you can protect a co-signer in a Chapter 7 bankruptcy. First, if the loan is a mortgage or auto loan, you can get or remain current on payments and keep paying. For auto loans or leases (the most common co-signer situation) you can opt to reaffirm the debt (but you have to do this so it is presented to the court before your discharge) This means that you waive the right to discharge that debt and confirm that you accept personal responsibility to pay it after the bankruptcy is final. If you do this and keep making payments on the debt even after the bankruptcy is final, action against the co-debtor is unlikely.
Chapter 13 offers much more protection to co-signers and guarantors on non-business “consumer debt” such as auto loans or leases. In Chapter 13, the automatic stay extends to co-signers and co-debtors under what is known as the “co-debtor stay.” While the stay will end when the Chapter 13 period expires, your co-signer will have protection for the three-to-five year term of the Chapter 13 reorganization.
A creditor may seek to have the stay lifted with respect to a co-signer under limited circumstances, including :
- A determination that it was the co-signer who actually received the benefit of the debt
- The creditor will suffer “irreparable harm” if the stay is not lifted
- The Chapter 13 plan does not call for payment in full by the end of the reorganization period
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