People who have poor credit or a limited credit history may choose to apply for a loan using a cosigner. When agreeing to become a co-signer, the applicant with stronger credit takes on the legal obligation to pay the debt incurred by the primary applicant in case of default. A common example of this scenario is when a parent co-signs a loan for a young adult child’s first car or student loan.

If the loan goes into default, the creditor must attempt to collect from the primary borrower first before demanding payment from the co-signer. However, creditors can attempt to collect funds from the co-borrower first if the primary applicant files for Chapter 7 bankruptcy. The reason for this is that the automatic stay, which is the legal term for immediately ceasing collection efforts, only applies to the person who filed for bankruptcy.

Sometimes, co-signers run into financial trouble of their own and need to file bankruptcy, creating a challenging situation for everyone involved. Here is what to expect if you find yourself in this situation as either the original applicant or the co-signer.

Chapter 7 Bankruptcy Wipes Out Obligation to Repay Most Consumer Debt

Each state maintains its own guidelines regarding who can file for Chapter 7 bankruptcy, such as maximum household income based on family size. Anyone who meets the guidelines to qualify for a discharge of bankruptcy no longer has the legal obligation to repay debts such as car loans, credit cards, and medical debt. This is true regardless of whether the bankruptcy petitioner was a primary applicant, joint applicant, or cosigner.

A person filing bankruptcy can reaffirm before the discharge that he or she intends to pay a specific debt. For example, the petitioner may decide to continue paying for a car loan to avoid having the vehicle repossessed. You need to carefully consider whether to reaffirm a debt since you will not be able to claim it in a future bankruptcy.

The option to reaffirm a debt is less likely to happen in a cosigner situation when one person agreed to the loan to help another person obtain credit but does not have access to the vehicle or other tangible collateral. Student loans and tax debt is not dischargeable in Chapter 7 bankruptcy in most cases.

Does a Co-Signer’s Bankruptcy Make You Entirely Responsible for the Debt?

The answer to this question is yes, but you do have some options. First, check with the lender to see if you can have the current cosigner removed from the loan. Just be aware that you may need to replace the person filing for bankruptcy with a new co-signer if your credit is still not strong enough to qualify for the loan on your own.

Another option to consider when your co-borrower files for Chapter 7 bankruptcy is to ask the creditor to refinance the loan. This process pays off the first loan and creates a new loan in your name only or with the name of your new cosigner. Unfortunately, most creditors will not remove a co-signer from a loan, even in the case of a pending Chapter 7 bankruptcy.

Another thing you should be aware of is that your co-signer’s bankruptcy status could be reflected on your credit report, even if you have always made payments on time. This situation is most common with student loans, and it may put the account in immediate default.

Once a creditor indicates a loan is in default, the law requires you to pay the balance in full immediately. You could face collection activity if you do not quickly arrange to repay the loan. The Fair Credit Reporting Act gives you the right to include a consumer statement on your credit report should this scenario play out. You can explain to future creditors that you always paid your loan obligations on time and that it was your co-signer who defaulted.

Speak to a Bankruptcy Attorney for Further Guidance

Clark and Washington, PC is an experienced bankruptcy law firm with offices in Atlanta and 10 other major cities throughout Georgia. Whether you intend to file bankruptcy or just have additional questions about the legal obligations of co-signers, we encourage you to request a free consultation with one of our attorneys. We spend time explaining the process and answering questions until we feel confident that you understand your rights as a Georgia consumer.