A cosigner is someone who has signed up to guarantee payment of a debt if the primary debtor fails to make payments. A cosigner is also called a codebtor in bankruptcy. Co-signers are usually friends or family members with good credit who are added to a loan to provide added 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. A bankruptcy by one cosignor affects the rights of the other cosignor.
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 co-debtor 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.
Chapter 7: Unfortunately, the cosigner gets no protection in Chapter 7 bankruptcy. While the person filing bankruptcy will have their personal liability wiped out by the Chapter 7, 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, in many cases the debtor in Chapter 7 debtor stops paying the debt. In such cases, it may make sense for the cosigner to file for bankruptcy as well, especially if the debt is for a large amount such as a mortgage.
Chapter 13: In Chapter 13, however, the cosigner gets some protection from the creditor and also can have their liability removed completely if the debt is paid for through the Chapter 13 repayment plan.
In Chapter 13 bankruptcy, the cosigner is protected by the codebtor stay, which prevents creditors from contacting them and trying to collect the debt. This stay applies if: 1) the cosigner is an individual (as opposed to a corporation or partnership), 2) the cosigner did not become liable for the debt in the ordinary course of business, and 3) the debt must be 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 court to have it lifted.
The creditor can argue that the stay should be lifted if: 1) your cosigner (rather than you) received the consideration for the debt (i.e., your cosigner received the property the funds were used to purchase); 2) your Chapter 13 plan does not include payment of that debt; or 3) 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 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 5 years) then the cosigner will not be liable for the debt once a discharge enters in the bankruptcy case. However, if the debt is not paid for in full, then the creditor can still attempt to collect the debt from the codebtor if the remaining balance on the debt is not paid following the Chapter 13 discharge. 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 is important to know how your bankruptcy will affect them. Having the advice of a bankruptcy lawyer can ensure that you cosigner issues are dealt with properly.