Debt, Co-Signers, and Filing for Bankruptcy

The decision to file for bankruptcy can be challenging because of the many circumstances that must be considered. However, those choices can become heavier when considering how a co-signer will be affected. Being a co-signer can greatly help a family member or friend, but there are risks associated with agreeing to be legally responsible for another’s debt. 

Bankruptcy is one of the risks a co-signer might face. Bankruptcy is a great tool for people who require relief from their debts. However, that relief doesn’t always extend to the giving friend or family member who agreed to be a co-signer. 

What Is a Co-Signer, and What Are the Risks? 

A co-signer is a person who agrees to be legally responsible for paying off the debt of another person if they can’t repay the amount borrowed. If the creditors can’t get the original loan recipient’s money, they will expect the co-signer to pay. This is why it’s important to consider all the pros and cons before becoming a co-signer. 

If a person has bad credit or is just starting to build their credit, having a co-signer is a great way to qualify for a loan. One in six adults will become co-signers to help out family or friends. Most co-signers help with auto loans, with 51% becoming co-signers. Another 24% of people will become co-signers to someone’s personal loans. 

Understanding the potential downsides is part of deciding if a person wants to become a co-signer. 

  1. Your only right is to be financially responsible if the primary borrower fails to pay their creditors. A co-signer does not have the rights to the property or money they have signed for. As a result, 38% of co-signers will repay some or all the loans. This can also affect the co-signer’s credit for better or worse, depending on the habits of the primary borrower. 
  1. Personal relationships can be affected by this agreement. According to Forbes, 26% of people claimed co-signing for a loan hurt their relationships with the person they tried to help. 
  1. The co-signer can be held responsible for the default loan amount. The Federal Trade Commission states that a co-signer can face collections before the primary borrower is held accountable. 
  1. A co-signer can be removed from a loan. However, this depends on the lender and if the primary borrower requests to let you go. If both the primary borrower and lender agree to release, only then is a co-signer off the hook for the loan. Co-signer releases exist, but they are mostly used for student loans and auto loans. Another way out for a co-signer is through refinancing of the loan. When a primary borrower chooses to refinance, it means they take out a new loan to pay off the original loan. When the original borrower does this, they may be able to refinance in their  name only. 
  1. If the primary borrower files for bankruptcy, that debt relief will only affect them. 

The main reason people become co-signers is to help family or friends. For some, that is all the reason they need, but how a struggling borrower chooses to handle their debt will impact a co-signer. 

Primary Borrowers and Chapter 7 

This chapter is a good way to wipe out debt for people having trouble paying back debts. Chapter 7 is a liquidation bankruptcy. To wipe out the unsecured and secured debt, assets must be taken. When people apply for bankruptcy, an ‘automatic stay’ happens, which means that the law requires creditors to stop collections against people. A ‘means test’ is given to see if a person qualifies for this chapter. 

When the primary borrower files for chapter 7, their eligible debt is discharged. However, those same creditors can then demand payment from the co-signer. The borrower who files chapter 7 has the automatic stay to protect them. However, that protection isn’t extended to the co-signer in chapter 7. So, while they can’t go after the primary borrower, creditors can go full force after the co-signer because they too are legally responsible for the debt. Fortunately, things can be done to protect them. 

Reaffirming a debt is one such option to protect co-signers. When people reaffirm the debt, they agree to remain liable for the debt. This happens by signing a new agreement with the lender. Because most co-signing loans are over cars, this is also a good option for the primary borrower. They get to keep the car while still paying back the creditor. 

Another option is to repay the debt in full. This is likely less of choice because the borrower is filing for bankruptcy. But, even if a person receives a bankruptcy discharge, it doesn’t mean they can’t voluntarily make payments. While it is understandable if this can’t be done, this is a good way to keep the co-signer out of trouble.

In either case, it’s best to speak with an attorney who can provide sound legal advice on this matter.

Primary Borrowers and Chapter 13

Chapter 13 offers a repayment plan for people in debt. The plans are created to last for three to five years and secured, and unsecured debts are included. The person’s disposable income is considered when making the plan. Unlike chapter 7, liquidation isn’t worth worrying about because the person is paying off their debts. This option is best for people who can make monthly payments.

As in chapter 7, an ‘automatic stay’ is enforced in chapter 13. The good news is that chapter 13 extends those protections to the co-signer. As a result, creditors won’t be able to go after co-signers with collections even if they didn’t go through bankruptcy themselves. 

This protection is great, but creditors can still pursue the ‘stay’ to be lifted through the courts. Here are some scenarios that can permit creditors to remove the ‘stay’: 

  • If the co-signer is getting the primary benefit of the loan. For example, if the person who cosigns for the car is driving it instead of the primary loan borrower. This will cause problems because legally the co-signer doesn’t have the right to the property they sign for. Doing this can result in the protection being lifted. 
  • If the chapter 13 plan won’t cover the co-signed debt in full. 
  • The creditor could object to the ‘stay’ if the primary borrower pays off the co-signed debt more than other debt. Although this choice may protect their co-signer, the creditors might prefer to be treated equally in the repayment process. 

An example of this last scenario would be if Jane has three credit card debts, each one $5,000 (for a total of $15,000). Under the chapter 13 plan, for the next four years Jane would pay $104 to each creditor. However, because one of Jane’s credit cards has a co-signer and she wants to protect that person, she proposes to allocate more money to that particular credit card debt. This will probably raise objections from other creditors because they aren’t treated equally in the repayment plan. 

Chapter 13 offers more protections than chapter 7. However, there is still a risk. Having a conversation with the person you signed for is recommended. This will give you insight into the options being considered and how they might affect you. It also gives you a chance to discuss what bankruptcy filing best meets the needs of all involved. This conversation should take place with an attorney who will have the expertise to deal with the complex legal issues associated with bankruptcy cases. 

How We Can Help

Bankruptcies can be difficult to handle, and worrying about both the initial borrower and the thoughtful family member or friend who agreed to co-sign a loan can make it even more complex. Getting advice from an attorney is an intelligent decision, whether you’re the one filing for bankruptcy or the co-signer. At Rosenblum Law, we support our clients through every step of the process when it comes to assessing a person’s debt situation and pursuing the best bankruptcy remedies. Contact us today to get started on a plan to get your financial future back on track.

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