Do Cosigners Receive Special Treatments in Bankruptcy?

Bankruptcy offers the ultimate protection that you can receive from your debts and creditors, no matter what debt situation you are in. But the issue is not with the one who is filing bankruptcy. It is about the cosigner, who signed debts with the bankruptcy filer.

How will bankruptcy start to treat the co-debtors or the cosigners? Will they be affected the same as the filers, or will something anomalous happen to them, like the situation getting more dangerous for the cosigners?

This post is meant to answer this thin but sharp aspect of bankruptcy. It is a critical question that financial experts in the DebtCC Community have been dealing with for quite some time. Let's take a plunge into what they have to say, and what you should know if you are in the firestorm of bankruptcy and cosigned debts.

The Benefits of Cosigning Debts

As personal finance experts note, cosigning debts has always shown better credit approvals. It serves as a form of guarantee that lenders value highly—having backup plans is essential in lending decisions.

Why Lenders Prefer Cosigned Debts:

Combined income strength: Credit approval is based on two individuals' combined income, presenting a stronger financial profile.
Reduced risk: Having two parties responsible significantly decreases the risk potential of loan defaults.
Shared responsibility: Both parties are equally obligated to maintain payments and protect the credit agreement.

However, cosigning becomes complicated when bankruptcy enters the picture. When one debtor files bankruptcy, the liability of the co-signer typically remains attached to the debt—unless both parties file bankruptcy and demonstrate sufficient reason at a personal level that they are unable to pay off the debts.

Expert Opinions on Bankruptcy and Cosigned Debts

Financial experts from the DebtCC Community emphasize that when protecting cosigners in bankruptcy, Chapter 7 bankruptcy is not a suitable option. The consensus among debt relief professionals is clear on this matter.

Why Bankruptcy May Not Be Ideal for Cosigned Debts

Community contributors believe that for co-signed debts, it's better to explore other debt relief options rather than immediately filing bankruptcy.

The reasoning: Cosigned debts mean dual responsibility. The cosigning agreement stipulates that if one borrower fails to make due payments, the co-signer or co-borrower is obligated to continue payments from where they were left off.

The Chapter 7 Problem

This creates a very disturbing situation when a debtor files Chapter 7 bankruptcy. This bankruptcy chapter offers no protection for the cosigner, meaning creditors can pursue this person even if the filer's name is removed from the debt.

The Chapter 13 Alternative

Chapter 13 bankruptcy will elongate the debt payment pattern and impose an automatic stay on the co-signer along with the filer, but the process can stretch for at least 3-5 years.

Expert recommendation: It may be better for parties to settle cosigned debts with lenders and creditors if the debt amount is beyond the scope of being paid off in full.

Chapter 7: No Protection for Cosigners

When examining whether cosigners receive special treatment in bankruptcy, the answer becomes clear when looking at Chapter 7 bankruptcy filings.

Chapter 7 Reality for Cosigners

If a Chapter 7 bankruptcy is filed, by no means will a cosigner stay protected. Creditors will start to pursue payments from the co-signer once Chapter 7 is filed.

Automatic stay applies only to filer: Chapter 7 protects only the filer from debt collection procedures under the legal automatic stay provided by the bankruptcy court.
No cosigner benefit: This protection is not available for the co-signer, and the debt liability as a whole does not get cleared.
Ongoing payment obligation: A co-signer can expect to keep up with ongoing payments, even if one of the borrowers has filed a Chapter 7 debt discharge bankruptcy.

Important: The debt obligation doesn't disappear for cosigners in Chapter 7 bankruptcy. They remain fully responsible for the debt even after the primary borrower receives discharge.

Chapter 13: A More Amicable Solution

Chapter 13 bankruptcy and cosigners share a very different relationship compared to Chapter 7. Chapter 13, which is known for reorganization of debts, offers more protection for co-signers.

Chapter 13 Protections for Cosigners

Chapter 13 extends the automatic stay to co-signers and delivers the same protection as the filer during the repayment period.

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Automatic Stay Extension: The automatic stay protection extends to cosigners, preventing creditors from pursuing them during the bankruptcy process.
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3-5 Year Protection Period: Cosigners are protected throughout the duration of the Chapter 13 repayment plan, typically lasting 3 to 5 years.
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Organized Repayment: Debts are reorganized into manageable monthly payments, protecting both the filer and the cosigner from collection actions.

Important Consideration

However, Chapter 13 cannot be a perfect decision if you believe that the co-signed debts can never be cleared for good. The process stretches the payment timeline but doesn't eliminate the debt obligation entirely.

Therefore, Do Cosigners Receive Special Treatments in Bankruptcy?

The answer depends entirely on which type of bankruptcy is filed.

Chapter 7 Bankruptcy

No special treatment or protection is available for cosigners when Chapter 7 bankruptcy is filed.

Creditors will pursue payments from the co-signer once Chapter 7 is filed
Only protects the filer under the automatic stay
Cosigners must continue payments despite the filer's discharge

Chapter 13 Bankruptcy

Extends protection to cosigners through the automatic stay during the repayment period.

Cosigners receive the same protection as the filer
Protection lasts throughout the 3-5 year repayment plan
Debts are reorganized with manageable payment terms

Recommended Course of Action

In such controversial situations, it's required to sit with lawyers along with the co-signers and discuss what options are open to you.

Important consideration: Bankruptcy is very good for handling personal debt profiles, but the situation definitely changes for co-signed debts. The impact on cosigners must be carefully evaluated before proceeding with any bankruptcy filing.

How to Protect Your Cosigner When Filing Bankruptcy

If you're concerned about the impact of your bankruptcy on a cosigner, here are practical steps you can take to minimize the damage:

1. Consider Chapter 13 Instead of Chapter 7

If protecting your cosigner is a priority, Chapter 13 bankruptcy offers the co-debtor stay protection. This may be worth the longer repayment period if it shields someone who helped you.

2. Enter a Reaffirmation Agreement

In Chapter 7, you can sign a reaffirmation agreement to remain personally liable for the cosigned debt. This protects your cosigner but means you'll still owe the debt after bankruptcy.

Note: Courts scrutinize reaffirmation agreements carefully and may not approve them if they create undue hardship.

3. Continue Making Payments Voluntarily

Even without a reaffirmation agreement, you can voluntarily continue paying cosigned debts. This protects the cosigner without legally binding you to the debt post-bankruptcy.

4. Pay Off Cosigned Debts Before Filing

If possible, prioritize paying off or paying down cosigned debts before filing bankruptcy. This completely eliminates the issue.

5. Communicate with Your Cosigner

Be honest with your cosigner about your financial situation and bankruptcy plans. Give them time to prepare financially and explore their own options, such as negotiating a payment plan, refinancing in their name, or seeking legal advice.

6. Negotiate with Creditors

Before filing, try negotiating with creditors to release the cosigner from obligation, accept a lump-sum settlement, or modify loan terms to make payment more affordable.

7. Consult a Bankruptcy Attorney

An experienced bankruptcy attorney can help evaluate whether Chapter 7 or Chapter 13 is better for your situation, understand the specific impact on your cosigners, and navigate reaffirmation agreements and co-debtor stays.

Remember: Actions Speak Louder

The best way to protect your cosigner is to take responsibility for the debt whenever possible. Whether through reaffirmation, voluntary payments, or choosing Chapter 13, demonstrating commitment to protecting those who helped you maintains relationships and integrity through difficult financial times.

Conclusion

Cosigners do not receive special treatment in Chapter 7 bankruptcy—creditors can immediately begin collection actions against them once the bankruptcy is filed. However, Chapter 13 bankruptcy offers better protection by extending the automatic stay to cosigners throughout the repayment period.

The Bottom Line

When dealing with cosigned debts, it's essential to consult with bankruptcy attorneys and involve cosigners in decision-making. Consider all available debt relief options, including debt settlement, before proceeding with bankruptcy that could impact your cosigner.

Facing Bankruptcy with Cosigned Debts?

Our bankruptcy counselors can help you understand how Chapter 7 and Chapter 13 will affect your cosigners and explore alternative debt relief solutions.