For individuals that are considering bankruptcy and have taken out debt with a cosigner, there are specific factors to evaluate before deciding whether to file Chapter 7 or Chapter 13. Usually, the debtor wants to know if the cosigner will be adversely affected during the bankruptcy proceedings, and what is the best solution.
Attorneys often go to great lengths in explaining exactly how the cosigner will be affected by the individual filing for bankruptcy. This is often a very delicate situation when the cosigner turns out to be a close friend or relative.
However, it is imperative that the individual understands all that is involved in the bankruptcy filing. Unfortunately, any cosigner to the debt will be treated significantly differently on the two available bankruptcy chapters.
Chapter 7 and Cosigners
Chapter 7 should be avoided at all costs if the individual filing for bankruptcy does not want to leave their cosigner holding the entire debt to be repaid. This is because even though the debtor will receive a complete discharge under Chapter 7 bankruptcy, the cosigner will still be left holding the bag, and completely responsible for paying off the debt.
Under US bankruptcy rules, the cosigner is recognized as a co-debtor. In fact, the cosigner is left unprotected, because they do not receive an automatic stay during the bankruptcy proceedings. This allows the creditor to come back with full force to have the cosigner pay off the debt.
To make problems even more confusing, the alternative Chapter 13 might also not be a wise solution for the debtor if they do not currently have enough income to pay down the debt through a restructured plan as required. There may be an option where the individual can reaffirm the debt assigned to the cosigner, which would alleviate any obligations of the cosigner to pay off the debt. However, this can be potentially risky for a variety of reasons. In effect, the individual, not the cosigner, could be fully liable for the entire debt, which would have been fully discharged under the bankruptcy filing.
Chapter 13 and Cosigners
The least risky and sometimes preferable solution is to file for bankruptcy under Chapter 13 whenever it is feasible. The attorney can set up the repayment plan under Chapter 13 to allow the filer to pay off the debt, which would minimize the cosigner’s exposure.
In addition, because an automatic stay is issued under Chapter 13, any creditor would have to cease their collection actions against both debtors while the plan remains under Chapter 13 filing. However, the automatic stay will not completely absolve the responsibility of the cosigner for paying down the debt should the original debtor fail to do so. The automatic stay however will allow the debtor to pay off the debt through the repayment plan, alleviating the need to involve the cosigner.
There are specific situations under bankruptcy laws which permit the creditor relief from the court ordered automatic stay to collect the money from the cosigner. These include:
- Ownership and Use – If the cosigner owns and uses the property purchased with the debt.
- No Debt Pay Down – If the original debtor has no intention of paying off the debt with or without a structured repayment plan.
- Irreparable Harm – If the creditor can show irreparable harm by continuing the automatic stay.
The final option that every debtor should consider when there is no other solution but to file Chapter 7 is to make specific arrangements between the debtor and the cosigner. This will be for full reimbursement of any payments made by the cosigner. It is often easier to deal directly with the individual that cosigned the loan than the creditor.