Thursday, May 31, 2012
I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?
As we discussed in our previous post, if the primary borrower defaults (or files bankruptcy), the co-signer will be required to pay the loan back. But what about the reverse situation?
How is the primary borrower affected if the cosigner files for bankruptcy?
Consider the same example: Adam wants to buy a car, but can only qualify for a loan with a co-signer. Betsy agrees to co-sign, but her name is not listed on the title as an owner of the vehicle. This time Betsy files for bankruptcy and obtains a discharge of the car loan. For the sake of simplicity, we will assume that Betsy has no ownership in the vehicle that may be attributed to her by the Trustee.
Adam is still legally obligated to repay the unpaid balance of the loan. However, when Adam pays off the loan, all liens will be released, and the title will be issued in Adam’s name. Most auto financing agreements make no distinction between the “borrower” and “co-borrower” aside from whose name the title will ultimately be issued to. As such, the bankruptcy of a co-borrower is similarly a breach of the terms of the loan, and could result in a default under the terms of the note. As before, the bankruptcy (and discharge) of the co-borrower’s obligation leaves the lender in a position where they can only pursue one individual, not two, in the event the loan is not paid.
This material departure from the original agreed upon terms could be considered a default, and in fact, many auto financing agreements specifically include such a term. However, it has been my experience that the lender will receive a greater financial return by accepting the primary borrower’s monthly payments than they would by repossessing the vehicle and selling it at auction, meaning that the primary borrower will likely keep the vehicle, despite the co-borrower’s bankruptcy.
In the event a co-borrower files for bankruptcy, the best thing that the primary borrower can do is seek to refinance the balance on the car loan, if possible. Many credit unions and some larger banks offer automobile refinancing loans. By refinancing the loan, the primary borrower has effectively paid off the loan securing the vehicle, and negated any circumstances which could trigger a default. If handled properly, and for a qualified borrower, it is often possible to keep payments the same, or even lower payments upon refinancing the car.
A borrower may be tempted to sign a reaffirmation agreement presented by the lender. However, executing the reaffirmation agreement is, in my opinion, not a legal guarantee that the bank will take no further action, nor will it cure any default under the terms of the note upon the co-borrower’s filing for bankruptcy. First, in order to cure the issue of default, at a minimum, the co-borrower filing for bankruptcy would have to sign. A reaffirmation agreement is an agreement arising in the context of a bankruptcy case. Here, the primary borrower is not seeking bankruptcy protection, nor is he electing to “remove” the debt from the discharge order; and therefore the primary borrower, Adam in our example above, has no standing to sign the reaffirmation agreement.
The bankruptcy of a co-borrower should not appear on Adam’s credit report, but because some lenders will automate their reports to credit agencies, there is a reasonable likelihood that the entry may make some indication of bankruptcy. If this happens, the information in the credit report is incorrect. It may be necessary to contact the three credit bureaus (Equifax, Experian, and Trans Union) as well as the lending institution to ensure that this information is correctly reported on the primary borrower’s credit report. Again, refinancing with a new loan is the simplest way to resolve this issue because then the loan will be listed as paid, and the new loan will report positively on a credit report (as long as you continue to pay it on time).
As with the decision to co-sign a loan, the decision to obtain a loan requiring a co-signer comes with significant legal consequences if the co-signer does not honor the terms of the note. Consider the need to take out a loan with a co-signer carefully, and if the co-signer files for bankruptcy , it may be worth your while to reach out to a bankruptcy attorney to better understand your options and obligations regarding the loan.