Seeking Bankruptcy Protection
When you first file your petition for bankruptcy, you must list all of your creditors, including the lender and your cosigner. If you file for bankruptcy under Chapter 7, you are asking the court to discharge, or wipe out, your entire obligation to repay the loan. If you file under Chapter 13, you will make reduced payments on the loan and other debts for three or five years. After that, the court will discharge whatever is left on the loan. The discharge – in either Chapter 7 or 13 – will also prevent your cosigner from taking legal action against you for reimbursement of any monies she paid to the lender.
If you successfully go through Chapter 7 bankruptcy, the court will discharge the loan, so you have no more legal obligation to repay it. But the debt still exists, and from the lender’s point of view, you defaulted on the loan. The lender will simply turn to your cosigner and demand she repay the unpaid debt. The lender can use its full arsenal of collection tactics against your cosigner, such as hiring a collection agency, suing the cosigner and garnishing her wages.
Reaffirming the Loan in Chapter 7
When you file for Chapter 7, you can - with the court’s permission - reaffirm the loan. This means you renew your promise to repay the loan, and the debt is not discharged in bankruptcy. Of course, you must continue making payments until the debt is paid off. Otherwise, the lender can take collection actions against you and your cosigner.
If you file for bankruptcy under Chapter 13, you would make monthly payments toward the loan and other debts on a court-approved schedule. During the repayment period, you – and your cosigner, in most cases – are protected by an “automatic stay,” which prevents the lender from taking collection actions. If you completely pay off the loan in the repayment plan, you and your cosigner owe nothing more to the lender. However, if you still owe money after the repayment plan is over, the court will discharge your obligation to pay the remaining amount. As a result, the lender will then attempt to collect the remaining balance from your cosigner.
Protecting Your Cosigner
Even though bankruptcy will remove your legal obligation to pay the lender, or reimburse your cosigner if she paid the lender, you may want to reimburse your co-signer anyway, especially since she is probably a family member or close friend. After your bankruptcy is discharged, you’re free to pay her back.