What Happens to a Cosigned Loan in a Bankruptcy?

By John Cromwell

When a debtor goes into bankruptcy, the people he owes money to are concerned that they will not receive what is owed them. One possible source of security for the creditor is the existence of a co-signer who is not going bankrupt. When someone co-signs a loan, he is obligated to step in and pay the outstanding loan if the primary borrower cannot meet his obligations. Courts are focused on the debtor’s financial obligations during bankruptcy, but the fact that a debt may be co-signed can make the bankruptcy process a little more complicated.

When a debtor goes into bankruptcy, the people he owes money to are concerned that they will not receive what is owed them. One possible source of security for the creditor is the existence of a co-signer who is not going bankrupt. When someone co-signs a loan, he is obligated to step in and pay the outstanding loan if the primary borrower cannot meet his obligations. Courts are focused on the debtor’s financial obligations during bankruptcy, but the fact that a debt may be co-signed can make the bankruptcy process a little more complicated.

Chapter 7 vs. Chapter 13

Under Chapter 7 bankruptcy, a debtor must sell some of his assets to pay off his debts. Some of his assets, such as his home and the tools of his trade, are exempt from being sold. This is to ensure that the debtor has enough assets to sustain himself after the bankruptcy process. Once the sale is complete, the proceeds go to his creditors and any remaining debts are absolved. Chapter 13 does not require the debtor to sell any of his assets. The debtor must present a repayment plan, based on his employment and assets, which pays off what he owes. Generally, this plan takes three to five years to complete. If the plan is approved by the court and the debtor complies with it, at the end of the process the debtor is absolved from any remaining obligations.

Protect your loved ones by a legally binding will. Make a Will Online Now

Co-Signed Loan in Chapter 7

When a person files for bankruptcy, his creditors cannot come after him to repay the loan while he is going through the process. The debtor’s co-signer is not afforded similar protection. Under Chapter 7, a co-signer is still responsible to pay the entirety of the outstanding liability regardless of the debtor’s financial condition. In this scenario, the debtor should include the debt on his bankruptcy petition and the co-signer as a creditor. This way, the co-signer can get a portion of the proceeds from the bankruptcy to minimize her loss from having to pay the whole debt.

Co-Signed Loan in Chapter 13

Chapter 13 bankruptcy is better for co-signers since they are protected from having to pay the debt immediately. The bankruptcy court will issue a stay for the co-signer, since under the Chapter 13 repayment plan, the original debtor will have a means to repay the debt without the co-signer having to do it. Generally, the co-signer is only on the hook if the debtor fails in following through on his repayment plan. Once the co-signed debt is paid off in its entirety, the co-signer is absolved from any remaining legal liability for the debt.

Adversary Proceeding

Even under Chapter 13, a creditor may attempt to lift the stay for the co-signer. The creditor may only do this if the co-signer actually received the property the debt was used to obtain, the repayment plan does not include payment of the debt owed to the creditor, or the stay would hurt the creditor. An example of how a stay could hurt a creditor would be if the debt is on a car, which is rapidly depreciating. By revoking the stay, the creditor could take back the car to resell it, minimizing the potential loss. If the court agrees, it may lift the stay and the creditor can attempt to obtain what it is owed from the co-signer.

Protect your loved ones by a legally binding will. Make a Will Online Now
Is a Cosigner Safe in a Chapter 13?

References

Related articles

Creditor Abuses & Bankruptcy Laws

When debtors start falling behind on their bills, bankruptcy may be the best option to stop harassing phone calls and other collection tactics. Before a debtor files for bankruptcy, he is protected from creditor abuses by federal law, but after he files for bankruptcy, bankruptcy laws provide even greater protection.

What Is a Petition to Lift a Stay?

The automatic stay in bankruptcy immediately stops most lawsuits by your creditors. In particular, it prohibits them from filing or continuing with suits to collect an unsecured debt. However, when a creditor has a lien on property in your possession -- such as a mortgage on your house or a car loan -- the creditor can file a request with the bankruptcy court to lift the automatic stay.

What Happens in Bankruptcy If Your Debt Is Sold to Another Company?

People who file for bankruptcy almost always share one goal – the end of creditor harassment. Once you file for bankruptcy, it is illegal for creditors to contact you in an attempt to collect most debts. This wall of protection is known as the “automatic stay.” But what happens if a creditor turns around and sells your debt to another creditor after you file for bankruptcy? Are you still responsible for the debt? Do you have to start the whole process over with the new creditor? The answers to these questions, respectively, are yes and no – but there are some helpful points to keep in mind if this happens to you.

LegalZoom. Legal help is here. Start Here. Wills. Trusts. Attorney help.

Related articles

How to File Bankruptcy With Unsecured Debt

Many people who file for bankruptcy do so because they seek a financial clean slate and relief from a heavy debt ...

What Happens to the Cosigner if the Signer Goes Bankrupt?

When someone cosigns a loan for you, they are promising to repay the money if you don’t. A lender will require ...

What Happens When You Reaffirm a Vehicle After Bankruptcy?

Bankruptcy allows you to get a fresh start financially, clearing up debts by paying some and dismissing others. Filing ...

Can You Include Returned Checks in Chapter 7?

When a debtor files for Chapter 7 bankruptcy, he must inform the court of all of his liabilities, including returned ...

Browse by category