How does filing bankruptcy affect a co-signer?

How a co-signer is affected will depend on the type of bankruptcy you file and the nature of the debt, namely a consumer or business debt.

Co-Signers in a Chapter 13 Filing

The Bankruptcy Code uses the term co-debtor to describe an individual who is also liable for a debt instead of co-signer. Under any type of bankruptcy, a discharge doesn’t eliminate the liability of a co-debtor. There is, however, what is known as a co-debtor stay in Chapter 13 cases that prevents creditors from pursuing rights against co-debtors until the case is closed, which may be 3 or even 5 years after the petition is filed. This stay will give you time to get repayment back on track so that creditors will not go after your co-signer.

Co-Signers in a Chapter 7 Filing

The result is different, however, in a Chapter 7 bankruptcy. If you receive a discharge of the debt, the discharge is specific to you. Because your co-signer was not a party, their part of the obligation is not discharged. This means that the creditor will turn their collection efforts towards your co-signer once your part is done.

Exceptions to the Co-Debtor Stay

There are exceptions to the co-debtor stay, however. If your debt arose in the ordinary course of business (as when you cosign an ordinary course loan to a corporation you control), there is no co-debtor stay because it is a business debt, not a consumer debt.

Additionally, if the co-debtor is the one who actually got the “consideration” for the debt (e.g., you cosigned a car loan for your daughter, who actually owns the car), and your Chapter 13 plan proposes not to pay the debt, or if the creditor’s interests would be irreparably harmed by continuation of the co-debtor stay, the creditor can seek relief from the court.

Case Studies: How Filing Bankruptcy Affects Co-Signers

Case Study 1: John and Sarah’s Joint Debt

John and Sarah are married, and they both co-signed a mortgage loan for their family home. Unfortunately, due to financial difficulties, they decide to file for Chapter 13 bankruptcy. While their liability for the mortgage debt cannot be discharged, the co-debtor stay in Chapter 13 prevents the mortgage lender from pursuing rights against Sarah, the co-signer, until their bankruptcy case is closed.

This gives John and Sarah time to reorganize their finances and make the mortgage payments, protecting Sarah from immediate creditor actions.

Case Study 2: Mark’s Student Loan and His Parents

Mark, a recent college graduate, has a significant amount of student loan debt that his parents co-signed for him. Unfortunately, Mark faces financial hardship and decides to file for Chapter 7 bankruptcy.

While Mark’s student loan debt is not dischargeable, his personal obligation to repay the loan is eliminated through bankruptcy.However, this does not affect his parents’ co-signer status. The student loan lender can now pursue repayment from Mark’s parents, who remain liable for the debt as co-signers.

Case Study 3: Lisa’s Business Loan Co-Signing

Lisa, an entrepreneur, co-signed a business loan for her friend’s startup. Due to the business’s failure, Lisa decides to file for Chapter 13 bankruptcy. However, the co-debtor stay does not apply in this case because the debt is classified as a business debt rather than a consumer debt.

The creditor can proceed with collection actions against Lisa as the co-signer, irrespective of her bankruptcy filing. Lisa must explore alternative options to address the business debt and protect herself from creditor actions.