Chapter 7 and Chapter 13 Bankruptcy Will Affect Your Cosigner Differently
When taking out a loan, you may use what’s known as a “cosigner.” A cosigner is someone who has signed up to guarantee payment of a debt if the primary debtor fails to make payments.
Cosigners are usually friends or family members with good credit who are added to a loan to provide additional assurance to the lender that the loan will be repaid if the primary borrower (who wouldn’t qualify on their own) fails to make all payments.
If you later find yourself in debt trouble and become unable to make payments, you may consider filing for bankruptcy. This can be a valid way to get your financial life back on track.
However, it’s important to know that a bankruptcy by one cosigner (also called a “co debtor” in bankruptcy) affects the rights of the other cosigner.
Because of the personal relationship shared by most codebtors, many people who are considering filing for bankruptcy are concerned about the effect their bankruptcy will have on their cosigner. This is a very valid concern because the cosigner has agreed to be responsible for the full amount of the debt if the primary debtor defaults on the loan. That means that if one codebtor files for bankruptcy, the other is on the hook for the full payment.
Additionally, the cosigner must be listed as a creditor in your bankruptcy case. This is so they have notice of your bankruptcy, but also so that any claim they may have against you for defaulting on the loan is wiped out and does not come back to haunt you after you receive a bankruptcy discharge.
If you’re in need of debt relief, it’s time to speak with a bankruptcy law firm to make sure you understand all your options and get the most desirable outcome. Wink & Wink of Denver, Colorado have been helping people and small businesses get debt settlement for over 10 years.
For most individuals and small businesses, there are two bankruptcy options: Chapter 7 and Chapter 13.
- Chapter 7 bankruptcy wipes out almost all your debts, including credit card debt, medical debt, rent/leases, and more.
- Chapter 13 bankruptcy creates a monthly payment plan to pay off your debts within 3-5 years.
The effect of bankruptcy on a cosigner varies based on which chapter of bankruptcy you file.
Speaking with a Denver bankruptcy attorney near you, such as Wink & Wink, can help you understand the ins and outs of bankruptcy and which chapter is the right choice for your situation.
Chapter 7 Bankruptcy’s Effect on Cosigners
In Chapter 7 bankruptcy, the cosigner unfortunately gets no protection.
While the person filing bankruptcy will have their personal liability wiped out by the Chapter 7 (as in, they won’t be liable to pay the debt), the cosigner will still be on the hook for the full amount of the discharged debt.
Sometimes, the debtor in Chapter 7 may continue to pay a certain debt, such as a home loan or auto loan so they can keep the house or car after bankruptcy. In such cases, the impact on the codebtor may be minimal. However, if the debtor in Chapter 7 stops paying the debt, it may make sense for the cosigner to either pay it or file for bankruptcy as well, or settle the debt. While it is a difficult situation, it is best for the person filing Chapter 7 to let the cosigner know when they stop paying the debt. Then, the cosigner can take appropriate action.
Chapter 13 Bankruptcy’s Effect on Cosigners
In Chapter 13, however, the debtor can continue paying the loan in full. This way, the cosigner gets some protection from the creditor and also can have their liability removed completely if the debt is paid.
In Chapter 13 bankruptcy, the cosigner is protected by the codebtor stay so long as the debt is getting paid, which prevents creditors from contacting them and trying to collect the debt. This stay applies if:
- The cosigner is an individual (as opposed to a corporation or partnership);
- The cosigner did not become liable for the debt in the ordinary course of business; and
- The debt is a consumer debt; that is, a debt primarily for personal, family, or household purposes.
If the debt meets these criteria, the automatic stay will apply unless the creditor petitions the Bankruptcy Court to have it lifted.
The creditor can argue that the stay should be lifted if:
- Your cosigner (rather than you) received the consideration for the debt (i.e., your cosigner received the property the funds were used to purchase);
- Your Chapter 13 plan does not include payment of that debt; or
- The creditor’s interest would be irreparably harmed by the stay (for example, if the bankruptcy filer might dispose of the property or if the property is rapidly decreasing in value).
If the Bankruptcy Court agrees and lifts the stay, then the creditor can attempt to collect the debt from the cosigner as if no bankruptcy had been filed.
If the Chapter 13 plan provides for the debt to be paid in full during the plan (usually five years), then the cosigner will not be liable for the debt once it is paid in full. However, if the debt is not paid in full, then the creditor can still attempt to collect the debt from the cosigner even if the debtor in bankruptcy gets a discharge on the debt. The creditor may also proceed against the cosigner if your Chapter 13 case is dismissed or converted to Chapter 7.
Because most cosigners are people you have a close personal relationship with, it’s important to know how your bankruptcy will affect them. Having the advice of a trusted bankruptcy lawyer can ensure that your cosigner issues are dealt with properly.