Many people have difficulty qualifying for credit because they don’t have a credit history, or that history has black marks on it. Others in this situation may qualify for credit, but with an out-of-reach down payment and higher fees and interest. The option of using a cosigner can be critical for people without established credit or with low credit scores to purchase cars, take out loans to cover emergency expenses, and meet other needs. A cosigned loan can also help establish or rebuild credit.
That need is more widespread than most realize. While many people struggling with debt and credit problems feel like they’re alone in those challenges, 39% of households in Alabama and Mississippi have debts in collection. In some areas, those rates are even higher: 40% in Jefferson County (Birmingham), 44% in Mobile County, and 48% in Montgomery County.
Ideally, a cosigner provides a bit of extra protection for the lender, helps the borrower secure a loan, and that’s the end of his or her role. The borrower pays off the loan on schedule, and the cosigner isn’t involved any further. It isn’t always that simple, though. In fact, when Princeton Survey Research International Associates surveyed cosigners a few years ago, 38% said they had ultimately been responsible for some or all of the debt. 28% said their credit scores had taken a hit.
Cosigners can be negatively affected when payments are late, when the borrower defaults, when the borrower files bankruptcy, and sometimes even when the loan is paid as agreed.
The Risks of Cosigning
While many people think of cosigning a loan as a guarantee that kicks in only if the borrower defaults, that’s not how most consumer “cosigning” arrangements work. Instead, the additional party is treated as a coborrower. That means the loan appears on the cosigner’s credit history.
That entry can have an impact even if the borrower makes prompt payments every time, because the cosigner’s credit report will show an outstanding debt. The apparent added monthly payment obligation can be an obstacle if the cosigner applies for a mortgage or other credit. If the borrower makes payments late, those negative entries will appear on the cosigner’s credit history as well. And, if the borrower defaults, the creditor may pursue collection action against the cosigner.
Collection Action against a Cosigner
In most cases, the cosigner’s responsibility is the same as the borrower’s. That means the cosigner is subject to a full range of collection activity, including:
- Phone calls and collection notices
- Negative credit reporting
- Debt transferred to a collection agency or sold to a debt buyer
- Debt collection lawsuits
If the creditor or debt collector gets a judgment against the cosigner, he or she could face wage garnishment, attachment of bank accounts, judgment liens against personal or real property and other collection action.
What Happens to a Cosigner in Bankruptcy?
With so much at stake for the cosigner, many people whose friends or relatives have cosigned for them are uneasy about pursuing bankruptcy. How bankruptcy affects a cosigner depends in large part on which type of bankruptcy the borrower files.
Chapter 7 Bankruptcy
When a borrower discharges a debt in Chapter 7 bankruptcy, the cosigner remains responsible for that debt. That’s a bit worse for the cosigner when the borrower is in default, because post-bankruptcy the creditor can’t attempt to collect from the borrower anymore. However, unless the cosigner also files bankruptcy or the debt is resolved in some other way, the creditor can still take a full range of collection action against the cosigner. While the borrower can opt to pay back the cosigner after the fact, he or she is not obligated to do so.
In the alternative, if the borrower agrees to repay the debt despite filing for Chapter 7 by signing a reaffirmation agreement, the cosigner will not be affected assuming the borrower makes all subsequent payments. The borrower must be current on his or her payments to enter into the reaffirmation agreement. However, reaffirmation agreements are usually limited to vehicle and mortgage payments.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy works differently and provides some protection for a cosigner. In most consumer bankruptcy cases; an automatic stay is entered right after the case is filed. The stay is a court order that temporarily stops creditors and debt collectors from trying to collect on outstanding debts. In Chapter 13 bankruptcy, the automatic stay generally protects cosigners, too.
The debtor in a Chapter 13 bankruptcy case makes payments across a period of three to five years. With limited exceptions, the automatic stay remains in effect for the duration of the repayment plan, if the borrower keeps up the payments and fulfills any other obligations. During that time, the cosigner remains protected by the automatic stay, meaning that creditors and debt collectors can’t pursue payment from the cosigner as long as the plan is in good standing.
Filing Bankruptcy with a Cosigner
The simplest way to protect a cosigner in bankruptcy is to file under Chapter 13 rather than Chapter 7. But the simplest answer isn’t always the best one. Sometimes, only one type of bankruptcy is available. For instance, to file Chapter 13 bankruptcy and get a plan confirmed, the debtor must be able to commit to making regular monthly payments for a period of three to five years. If the debtor’s income isn’t sufficient, it may be impossible to get a Chapter 13 plan approved.
If you are considering bankruptcy and a cosigner is obligated on one or more of your debts, the best starting point is to consult an experienced local bankruptcy attorney. Bond & Botes offers free consultations to people struggling with debt in Alabama, Mississippi and Tennessee. You can schedule yours right now by calling 877-581-3396 or filling out the contact form on this page.