Deciding whether to file for bankruptcy or not can be a difficult decision. You’ll prepare yourself for the good and the bad that comes along with bankruptcy. But what if your filing also causes fallout for someone who shares your debt? How does bankruptcy affect a cosigner?
A cosigner may have helped you obtain an important loan and now you want to make sure his or her credit score doesn’t take a hit because of your debt issues. The good news is there are ways to prevent the damaging effects of bankruptcy from spreading to your cosigner.
How Does Bankruptcy Affect a Cosigner?
Cosigners sign a credit application along with a co-borrower. This is usually to give the other borrower a better chance at securing the loan. The co-borrower may not have the best credit score and/or has fewer assets that can serve as collateral. Cosigners are usually included in the loan application process because they are on stronger financial ground. Having a cosigner provides extra security for the creditor and makes them much more likely to approve a loan.
Cosigners are often parents or close relatives who want to help a family member secure a loan for a car or a house. It’s not something to take lightly. A cosigner guarantees the creditor that they will repay the debt if the co-borrow defaults on the loan.
Spouses can also serve as cosigners on joint purchases and loans. Creditors often require both partners’ names on a loan contract regardless of the couple’s financial situation. Couples can file for bankruptcy together or separately. There are advantages to both options. You can learn more about how bankruptcy works when spouses file for bankruptcy alone and as a couple.
By filing for bankruptcy, you seek to either wipe away qualifying debt in discharge or to work out an agreement to only pay off only a percentage of your debt. It’s largely the difference between a Chapter 7 filing and a Chapter 13 filing. The choice between the two can greatly affect how much of a financial hit your cosigner takes.
Chapter 7 Bankruptcy And Cosigners
A successful Chapter 7 bankruptcy bid provides you with a discharge of much of your qualifying debt. The problem is that while you may be free and clear of much of your debt, a cosigner not involved in the bankruptcy could still end up liable for the entire amount of the loan you’ve escaped.
There’s also an “automatic stay” granted to you as you wait for the Bankruptcy Court to go over your Chapter 7 bankruptcy filing. This stay keeps creditors from calling you while you wait to hopefully receive a discharge of your debt. This protection isn’t always extended to your cosigner.
Protecting Cosigners in Chapter 7 Bankruptcy
There are actions you can take to protect a co-borrower as you file for Chapter 7 Bankruptcy:
- Reaffirming Debt. You can keep secured debt like a car loan out of bankruptcy proceedings by negotiating a new loan agreement through a reaffirmation of the debt. This keeps the balance in question from being dispelled by a Chapter 7 discharge, but it also allows you to continue making payments and keep the asset. Since you are still making payments your creditors won’t be going after your cosigner for the money.
- Paying Off the Debt. You can talk about your financial situation with your cosigner. Rather than face the penalties and uncertainty of your Chapter 7 Bankruptcy, the cosigner can pay the debt off in one lump sum if they are able. Working something out between the two of you may be preferable to leaving your fates up to the court.
- Considering Chapter 13 Bankruptcy. Talking over your circumstances with a bankruptcy law expert may convince you that it’s better for you and your co-borrower if you file for Chapter 13 Bankruptcy to give a cosigner better protection.
Protecting Cosigners in Chapter 13 Bankruptcy
Chapter 13 bankruptcy allows debtors and their bankruptcy attorneys to propose a three to five-year plan to pay off a percentage of the debt the filer carries. While fewer debts are discharged, filers are allowed to keep more of their possessions, and cosigners face less financial uncertainty. It may also be in the cosigner’s best interest to help the filer keep up with these payments so that debt concerns don’t return.
Chapter 13 Automatic Stay for Cosigners
As a Chapter 13 filer, you are granted an automatic stay similar to the stay in the Chapter 7 process. The good news is that with Chapter 13 the cosigner also enjoys much of the protection of a stay.
The stay prevents creditors from taking certain actions to get their money from you and your cosigner. All collection efforts and legal action are halted. Creditors must deal with the bankruptcy court and your bankruptcy trustee to recover their money.
Your co-borrower enjoys most of this protection too. However, some loans secured through an individual’s business may not qualify for this protection.
Most of the debt included in a Chapter 13 payment plan doesn’t end up falling to the cosigner unless the terms of the bankruptcy agreement aren’t met. The payments must be made over the length of Chapter 13 plan to avoid further penalties.
Cosigners and Credit Report Damage
Thanks to changes in the credit report process, cosigners usually don’t have to worry about a bankruptcy showing up on their credit simply because a co-borrower has filed. The debt they share will still be listed on the cosigner’s records until it is paid off, but bankruptcy should not appear if the cosigner wasn’t part of the filing.
Advancements in how credit reporting is handled have improved the plight of cosigners. Previously, reporting was done by each account. So if one of the debtors on an account filed for bankruptcy, the bankruptcy would show up on the credit report of everyone else associated with the account.
Nowadays, credit reporting is done individually. As long as no mistakes are made in the co-borrowers bankruptcy filing, the cosigner’s credit report should stay clean.
Checking for Cosigner Credit Issues
Unfortunately, sometimes mistakes are made. Bankruptcy can still show up in places it shouldn’t. This could result from an error made in the Chapter 7 or Chapter 13 filing. A smaller credit reporting company might also rely on an outdated system that still uses older methods of record keeping.
Cosigners can stay vigilant to catch these errors. They should inspect their credit reports at least twice during the co-borrowers bankruptcy proceedings. The first check should come about 4-5 weeks after the co-borrower has filed. A second check should occur a few months after the co-debtor earns a bankruptcy discharge.
When a bankruptcy suddenly appears on the cosigner’s report a complaint can be made to have it removed. Keep in mind that cosigners can’t remove late-payment notifications and other negative records that may hit a credit report after a co-borrower has left an account in default.
Can I Keep My Bankruptcy from my Cosigner?
No, you cannot keep your bankruptcy a secret from your cosigner. After your bankruptcy filing, all creditors and debtors associated with your loans will receive notification in the mail. So your cosigner will eventually be informed.
Even when the lines of communication aren’t open between you and your co-debtor, you should strongly consider giving him or her a warning. By providing a heads-up, there may be steps a cosigner can take to remove some of your debt before you hit bankruptcy. The cosigner could also work out an arrangement that keeps you out of bankruptcy entirely. It may be the best option for both parties.
Avoiding Preferential Debt Payments for Cosigners
There is one thing to watch out for as you approach a bankruptcy filing. If you had the choice, you’d probably rather leave your cosigner, who may be a close family member, out of your bankruptcy proceedings entirely.
However, pooling all of your resources to pay off a debt you share with a cosigner just before filing can raise red flags for bankruptcy trustees. Giving preferential treatment and using all of your available money to pay off one debt while you ignore many other creditors can get you into hot water. Those preferential debt payments can end up nullified if the Bankruptcy Court finds fault in your actions.
Contact A Los Angeles Bankruptcy Lawyer Serving Southern California
Someone may have reached out to you to provide financial help in a time of need. The last thing you’d want to do is repay your cosigner’s kindness by entangling him or her in a bankruptcy filing. There are ways to protect a co-borrower from harassment from creditors and dings on credit reports.
You should bring your concerns to a bankruptcy attorney with a strong background in defending clients going through desperate financial times. If you are worried about the negative effects bankruptcy can have on close friends and family, talk over your case with The Law Offices of Steers & Associates. Our attorneys are waiting to discuss your case in a first consultation that comes at no charge to you. You may feel you have few options, but don’t make any decisions until you speak with a legal professional.
For a free bankruptcy consultation in Los Angeles or anywhere across Southern California please contact us today. The Law Offices of Steers & Associates handle bankruptcy cases of all sizes and have stood by their clients through difficult times to help them earn financial freedom.
Elena Steers is a highly experienced bankruptcy attorney, the founder of Law Offices of Steers & Associates, and previously worked as a Bankruptcy Trustee Assistant at the Office of the Chapter 13 Trustee in Los Angeles. Her current affiliations include the State Bar of California, National Association of Consumer Bankruptcy Attorneys, and Central District Consumer Bankruptcy Attorneys Association.