Effect of Bankruptcy to co Signers on Loans

The effects of bankruptcy on an individual can range from a general inconvenience to devastation.  When you add in the ways that a bankruptcy can affect your friends and loved ones, this only makes the process more difficult.  One of the ways that friends and loved ones can be pulled into a bankruptcy situation is if they are co-signers on any of the debtor’s loans.  Although there is no guarantee, tin general a bankruptcy by one co-signer will not have a major effect on the co-signers.  There are, however, some exceptions.

First, the general rule.  In most cases, co-signers on loans sign “jointly and severally.”  This means that the debt is owed by both of them as a group, and by both of them individually.  This makes sense when you consider the reason why most lenders ask for a co-signer in a particular case.  It usually happens when the lender is not convinced that the first borrower will be able to pay back the loan on time.  So the lender requires a second person to put themselves on the hook in case the first one cannot pay.  In this respect, the bankruptcy is just what the lender was afraid was going to happen: one borrower cannot repay, and the lender wanted that second name on the loan to account for just this situation.  Regardless of what happens to the first person, the lender maintains full rights to come after the co-signer for payment of the debt.  In fact, in many cases a creditor holding a note with a bankrupt debtor will successfully petition the bankruptcy court to not include that lone in the schedule of debts that will be disposed of in the bankruptcy.

There are, however, some ways that a co-signer might be impacted by a bankruptcy.  First, it is very likely that there was some financial distress in the time leading up to the bankruptcy.  This means that the first borrower might have been missing payments, accruing late fees, or adding fees for returned checks.  All of these additional fees and interest, if there are any, will be added to what the co-signer is required to pay.  In addition, the lender may or may not be reporting the late and missed payments to both of the borrowers’ credit files.

Second, if the first borrower declares bankruptcy and the creditor knows that it is down to just one person who might be able to repay the loan, the creditor might re-evaluate the debt.  In the case of a revolving line of credit, the bank might lower the credit limit to reflect the fact that the bank is concerned about the debt being repaid.  Some loans carry the right for the creditor to accelerate the payment terms and demand payment, and the bankruptcy of one borrower is just the type of event that might lead a lender to do that.

Third, a lender might be persuaded to reevaluate the terms of the agreement in light of the bankruptcy.  Of course the main reason why the lender wanted a co-signer in the first place was to avoid that, but some creditors will consider shifting the debt to just the co-signer’s name, or revising the payment amount or rate, to reflect the fact that the co-signer is now taking over the responsibility of paying.

Finally, in the event that the debt is included in the schedule of debts on a bankruptcy, the lender may report that fact on both the signer and the co-signer’s credit files.  This would be the worst possible outcome for the co-signer, because that bad mark will remain on the books for at least seven years.  Although the co-signer could explain that this discharge of debt was because of the other borrower’s bankruptcy, this will only partially offset the effect of a debt discharge on the co-signer’s record.

The specific ways that a bankruptcy might impact a co-signer can vary.  If the debt is large or the arrangements are complicated, an accountant or bankruptcy attorney might be able to give a more detailed answer that is tailored to the specifics of an individual case.  But the general rule is that the lender wanted a co-signer so that the debt would be repaid in full even if the primary borrower defaulted, and that means that the co-signer will be making those payments.