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Life in California is expensive and it’s tough to get credit. Having a cosigner or guarantor can make life a lot easier. Maybe your parents cosigned your auto loan. Maybe you cosigned a mortgage loan with your spouse. Now you’re considering filing for bankruptcy. How will your filing affect your cosigner?
Below, we’ll go over the following:
- What is a cosigner?
- What happens to your cosigner’s debt if you file for bankruptcy?
- What happens to your cosigner’s credit score?
- What happens if your cosigner is the one to file for bankruptcy?
What is a cosigner?
A cosigner is someone who agrees to be legally bound to repay a loan if the primary borrower can’t pay. Lenders may require cosigners for borrowers with no credit history, bad credit, or low income. They have a better chance of collecting on a loan backed by someone creditworthy.
Cosigners are slightly different from guarantors. Creditors can pursue cosigners at the same time for collection, but must attempt to collect from a primary borrower before pursuing the guarantor. For bankruptcy purposes, cosigners and guarantors are treated the same way because they’ll both be liable for the debt.
What happens to my co-borrowed debt when I file for bankruptcy?
After you complete the bankruptcy process in California, your remaining unsecured debts are discharged. You are no longer legally obligated to repay them. That applies to debts for which you have a cosigner or have a guarantor. However, your discharge doesn’t extend to your cosigner or guarantor. This is an important thing to remember up front when you are asking someone to be your co-signer or guarantor. They need to be made aware that this is a part of the equation.
Cosigners and Guarantors in Bankruptcy
The effect of your bankruptcy on your co-borrower depends in part on the type of bankruptcy you’re filing. Under both Chapter 7 and Chapter 13, you get the protection of the automatic stay when you file. The automatic stay prevents creditors from trying to collect from you. Your co-borrower, on the other hand, may not receive the same protection.
Cosigners and Chapter 7
Under Chapter 7, the automatic stay does not extend to cosigners and guarantors. As soon as you file for bankruptcy, creditors can start to pursue your cosigner or guarantor for collection. Basically, it’s as if you defaulted on the loan.
How can I protect a co-borrower?
First, the co-borrower can take over the loan. Banks may not notify a cosigner or guarantor that a payment has been missed, so you should notify your co-borrower before you miss a payment so they can keep the loan current. In general, you should always keep careful track of the payments on any loan for which you’re a co-borrower. Missed payments will affect both parties’ credit score and open the door for repossession, foreclosure, and lawsuits. If the co-borrower continues to make payments on time, they won’t be otherwise affected by your bankruptcy. The party filing for bankruptcy will list the asset as “surrendered” on their bankruptcy schedules and the co-borrower will become the only party to the loan.
If your co-borrower doesn’t want to take over the loan, you can choose to reaffirm it. Reaffirming a debt is a serious decision for a bankruptcy filer. You’re agreeing to continue to be personally liable for the loan. Reaffirmation also means that you can’t discharge that debt in a future bankruptcy. You’ll continue to make your payments and your cosigner or guarantor will continue to be liable in the event that you default.
Finally, you can choose to continue to make the payments through your co-borrower throughout and after your bankruptcy. You won’t be legally liable for the debt, but you may volunteer to pay.
Cosigners and Chapter 13
Under Chapter 13, co-borrowers get much greater protection. When you create your Chapter 13 payment plan, you can include the cosigned debt and continue to make your regular payments. In addition, if you are agreeing to pay the debt in full, co-borrowers get the benefit of the automatic stay. When applied to cosigners and guarantors, it’s called the “co-debtor stay.”
Creditors may request that the court lift the stay if your co-borrower actually received the benefit of the loan (for example, you cosigned on an auto loan and the non-filing party got the car). They may also request relief from the stay if your Chapter 13 plan doesn’t allow for full repayment of the debt.
If you file under Chapter 13, your bankruptcy won’t affect your co-borrower as long as you make your payments. If you start to miss plan payments, your co-borrower is protected by the stay as long as your bankruptcy lasts. If you pay off the entirety of your co-borrowed debt through your bankruptcy plan, your co-borrower won’t be affected. If you don’t pay the whole debt and have to continue making payments after your bankruptcy ends, your co-borrower won’t be affected as long as you make the payments.
Generally, the only debts that extend beyond a Chapter 13 bankruptcy are mortgage loans. If your case is dismissed, however, creditors can immediately begin to pursue your co-borrower for collection.
What happens to my cosigner’s credit score if I file for bankruptcy?
When you file for bankruptcy, your credit score will drop between 100 and 300 points. The same is not necessarily true for your co-borrower. As long as your creditor continues to receive the loan payments, your co-borrower’s credit score shouldn’t take a hit. To the lender, it doesn’t matter if you’re paying or if your cosigner is paying. If the account is kept current, your bankruptcy won’t affect their credit score.
The fact that one party files for bankruptcy doesn’t necessarily make the cosigner any less creditworthy. The account you’ve cosigned on will, however, show on the non-filing party’s credit report as being involved in a bankruptcy.
If you miss payments on the account, your cosigner’s credit score will suffer. To a credit bureau, the two cosigning parties are the same person. One missed payment affects the scores of both people.
What if my guarantor or cosigner files for bankruptcy?
When you file for bankruptcy, it affects your cosigner or guarantor. The inverse is also true — if your cosigner or guarantor files for bankruptcy, it may affect you.
In some cases, a guarantor’s bankruptcy may throw you into default even if you’re current on payments. Generally, this applies to student loans. In the case of student loans, if the co-signer is no longer able to pay (even due to the fact that they have passed away) the balance on the loan may immediately become due. The default may affect your credit score, regardless of whether you’re current on payments. When you default, you have to pay the entire balance of the loan up front or face a collection action.
If your guarantor is going to file for bankruptcy, your best option is to ask to have them removed from the loan account. Lenders may allow it if you’ve been making your payments and have the resources to continue doing so. You may also be able to find a new guarantor or cosigner.
If your cosigner is going to file for bankruptcy, you’ll be responsible for the entire loan. If you don’t make the payments, your credit score will suffer. Unfortunately, lenders generally won’t remove cosigners from a loan account. You’ll have to work with your cosigner to make sure you don’t suffer for the sake of her bankruptcy.
If your co-signer files for bankruptcy or is no longer able to pay, make sure to monitor your credit report carefully. If the state of your co-signer affects your credit score, despite the fact that you have been paying your loans off in a timely manner and have a plan to continue to do so, you may be able to file a dispute with the credit rating agencies and have this corrected.
The Bottom Line
When you cosign or guarantee a loan, you accept the risk that the other party won’t pay. When you file for bankruptcy in California, be mindful of the effect it will have on anyone financially entangled with you. If you’re considering filing for bankruptcy, reach out to an experienced bankruptcy attorney to determine how best to protect your co-borrower and navigate your bankruptcy. Our legal team is available to help with a free consultation.