How Does Filing for Bankruptcy Affect a Cosigner?
May 13, 2024
Bankruptcy is a step that many take as a last resort to manage overwhelming debt. The process of filing for bankruptcy not only impacts the individual filing but can also have significant implications for cosigners on existing loans and debts.
When you decide to file for bankruptcy, it's important to understand the repercussions it has on those who've pledged to share financial responsibility for your debts. Cosigners, who are often close friends or family members, may face potential financial strain due to your choice to file for bankruptcy. When it comes to cosigners and bankruptcy, it's imperative to consult with an experienced attorney who understands bankruptcy law.
At Deborah Brooks & Associates, P.C., I have over 20 years of experience helping my clients with bankruptcy-related cases. Located in Oklahoma City and Lawton, Oklahoma, I proudly serve clients throughout Western Oklahoma, helping them work through the challenges of filing for bankruptcy and understand the impact their decisions may have on cosigners.
What Is a Cosigner?
A cosigner is someone who agrees to take on the legal obligation to repay a loan if the primary borrower fails to make payments. This role is typically required when the primary borrower does not have sufficient credit history, income, or financial stability to satisfy the terms of a loan on their own.
With a cosigner, lenders are provided with an additional layer of security for the loan, making the borrower more appealing for approval. Cosigners are common in various lending scenarios and may include but are not limited to:
Student loans: Often necessary for young adults who have not yet established a strong credit history.
Auto loans: Particularly for those who are purchasing their first car or have a low credit score.
Mortgages: In some cases, to help qualify for a home loan with better interest rates.
Personal loans: Used for consolidating debt, making large purchases, or covering unexpected expenses.
Credit cards: Some credit card companies allow a cosigner to help an individual qualify for their first credit card or rebuild credit.
In each of these situations, the cosigner must have a good credit history and the financial ability to cover the loan payments if the primary borrower defaults. This can lead to significant responsibility and risk for the cosigner.
Understanding Bankruptcy
Bankruptcy is a powerful legal tool designed to provide individuals and businesses with a fresh start by dismissing or restructuring their debts. It's governed by federal law, primarily under the U.S. Bankruptcy Code, and is intended to help those who are unable to repay their debts to creditors.
The goal of bankruptcy is to provide financial relief to debtors while making sure creditors are paid back. The two most common types of bankruptcy are Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
Often referred to as "liquidation bankruptcy," Chapter 7 allows debtors to discharge of most their unsecured debts, such as credit card debt, medical bills, and personal loans, giving them a debt-free slate at the end of the bankruptcy process. However, it often requires the debtor to sell (liquidate) some of their assets through a bankruptcy trustee to pay back a portion of their debt.
It's important to note that not everyone qualifies for Chapter 7. Eligibility is determined by a means test, which compares the debtor's income to the median income of their state. If the debtor's income is too high, they may not qualify. Most Chapter 7 cases are resolved within 3 to 6 months, which makes it an attractive option for more immediate debt relief.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy, often known as a "wage earner's plan," enables individuals with regular income to develop a plan to repay all or part of their debts. Under this chapter, debtors propose a repayment plan to make installments to creditors over three to five years.
Unlike Chapter 7, Chapter 13 allows debtors to restructure their debt, which may lower their monthly payments, and does not require the debtor to liquidate assets. This option is particularly beneficial for those who have a steady income and wish to avoid foreclosure on their home, as it can help debtors catch up on missed mortgage payments through the repayment plan.
Qualifying for Chapter 13 involves meeting certain debt limits outlined in the Bankruptcy Code, and the debtor must also complete credit counseling from an approved agency before filing a petition.
How Is a Cosigner Affected in a Bankruptcy Scenario?
When an individual files for bankruptcy, the role and obligations of a cosigner come under scrutiny, primarily because bankruptcy filings can significantly affect the financial responsibilities and credit of the cosigner. Understanding how a cosigner is impacted requires a close look at the type of bankruptcy filed and the specific details of the cosigned debt.
Impact on Cosigner Financial Responsibilities
In a Chapter 7 bankruptcy scenario, the debtor’s obligation to repay the cosigned debt may be discharged, leaving the cosigner solely responsible for the debt. Creditors can then pursue the cosigner for any outstanding balances since bankruptcy only protects the person who filed for it, not the cosigner.
For secured debts, such as car loans or mortgages, this could mean the cosigner has to keep up with payments to avoid repossession or foreclosure. This might put a strain on the cosigner’s finances and potentially damage their credit if they are unable to keep up with the payments.
Chapter 13 bankruptcy, however, offers slightly more protection for cosigners under the "co-debtor stay" provision. This provision extends protection to cosigners, preventing creditors from collection attempts against them while the bankruptcy plan is in effect.
However, this protection is conditional and only applies to consumer debts, not business-related debts. For the cosigner to remain protected, the bankruptcy filer must include the cosigned debt in their repayment plan and adhere to the scheduled payments. This protection remains as long as the bankruptcy case is active, or until the court decides otherwise.
Impact on Cosigner Credit Score
The impact of bankruptcy on a cosigner can extend beyond immediate financial obligations. The cosigner’s credit score may be affected, and their ability to qualify for future loans could be compromised due to their increased debt-to-income ratio.
Therefore, both parties must understand the potential consequences of a bankruptcy filing and possibly explore alternatives that could protect the cosigner’s interests, such as refinancing the debt or having the bankruptcy filer assume full responsibility for the cosigned debt before filing.
How to Protect a Cosigner When Filing for Bankruptcy
Before filing for bankruptcy, it's important to explore additional avenues for debt relief that could better safeguard the cosigner's financial stability and creditworthiness. Some of these include:
Consider Chapter 13 over Chapter 7: Chapter 13 can offer more protection for cosigners than Chapter 7. The "co-debtor stay" in Chapter 13 prevents creditors from pursuing the cosigner for debt repayment as long as the bankruptcy plan is adhered to.
Reaffirm the debt: Reaffirming a cosigned debt is a legal agreement that excludes the debt from bankruptcy discharge. This means the debtor remains legally obligated to pay back the loan, protecting the cosigner's finances and credit score.
Modify the repayment plan: In Chapter 13, the debtor can propose a repayment plan that includes prioritizing the repayment of the cosigned debt. This strategy ensures the cosigner is not left to shoulder the financial responsibility alone.
Cosigner release: Some loans, especially student loans, offer a cosigner release option after a specific number of on-time payments have been made. If possible, you should aim to qualify and apply for a cosigner release before filing for bankruptcy.
Refinance or consolidate: Before filing for bankruptcy, consider refinancing or consolidating the cosigned debt into a new loan that is solely in your name. This action removes the cosigner from any debt repayment obligation.
Negotiate with creditors: Sometimes, creditors are willing to modify the loan terms, allowing for lower payments or a temporary pause.
Each of these steps requires careful consideration and, in some cases, the cooperation of creditors. The overriding goal is to minimize the financial impact on the cosigner while allowing the debtor to proceed with bankruptcy as a means of regaining financial stability.
Seek Experienced Legal Advice
Bankruptcy laws are complex, and filing for bankruptcy for debt that has a cosigner can pose numerous challenges. If you are struggling with unmanageable debt for a loan that has a cosigner, a knowledgeable bankruptcy attorney can help.
At Deborah Brooks & Associates, P.C., I can offer you the help you need to resolve financial dilemmas for both you and your cosigner. Contact my firm today to schedule a free consultation.