Lenders often only grant loans if the borrower has a third party stand as guarantor, considering the borrower themselves to be too risky. Many people co-sign for loans without fully understanding the consequences. In effect they are guaranteeing to pay the loans if the named borrower fails to do so and they are equally liable for the debt. A co-signers credit standing is negatively affected if the loans are not paid in compliance with the loan agreement and they will be subject to collections activity. It is important that co-signers are also aware of the effect of the borrower declaring bankruptcy.
Bankruptcy if often the measure of last resort for those struggling with consumer debt. Whilst chapter 7 bankruptcies are the most usual form, chapter 13 bankruptcy affords more protection for co-signers. When a debtor is legally discharged from paying a debt under chapter 7 bankruptcy, the debt itself is not discharged. It remains the legal responsibility of the co-signer who has guaranteed the repayments.
Under bankruptcy law the co-signer becomes the co-debtor. The co-debtors credit will not be adversely affected by the bankruptcy if they pay the loan they co-signed for. However, if they fail to do so it will affect their credit negatively and they should expect to be pursued for the debt.
If the borrower fails to meet the payments on a loan and the co-signer does not make the payments, this will have a definite negative impact on the co-signers credit. If the loan is included in a chapter 7 bankruptcy the borrower can reaffirm the debt after their assets have been liquidised. In this case the creditor will not pursue the co-signer for the debt as long as the borrower meets the reaffirmed debt.
A Chapter 13 bankruptcy provides more protection for the co-signer as the borrower enters into a court ordered repayment plan with the creditor. During the term of the plan the co-signer is released from liability, provided the bankruptcy is only for consumer debt and the co-signer has not benefited in any way. However at the close of the plan the co-signer resumes liability for the debt.
A common scenario is for issuers of private student loans to require a co-signer. In the event of bankruptcy student loans are non-dischargeable but co-signers will remain equally liable for any debt.
It is advisable for the borrower who is seeking bankruptcy to take legal advice if a co-signer is involved and is concerned about the effect the bankruptcy would have on the co-signer.
Co-signers should also consider the implications of standing as guarantors as often end up liable for the debt they have co-signed. It is entirely possible for the borrower to walk away from loan debt through chapter 7 bankruptcy with no regard for the consequences to the co-signer.