Good Idea, Bad Idea - Cosigning a Loan

There are many good reasons why you may want to cosign a loan.  Some typical examples include helping a child obtain their college education by co-signing student loans, or assisting your spouse in purchasing a car. With any good idea, however, a small difference in the situation can make it a very bad idea.

Many people are unaware of the consequences of cosigning a loan, and in many many instances cosigning may be a very bad idea.  Take just the two examples described above:  If your child is unable to find a job after college and therefore unable to pay their student loan, that loan will be your responsibility.  If you and your spouse separate and he or she stops paying their car loan, your credit will be affected as well (even if they still have the car).

In these previous three posts we explored what happens when a cosigner or the primary borrower on a loan declares bankruptcy:

What happens to my Cosigner if I file for Bankruptcy?

I co-signed a loan and the primary borrower has filed for bankruptcy. What should I do to protect myself?

I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?

The short answer is simple: IF YOU SIGN A PROMISSORY NOTE, YOU HAVE A RESPONSIBILITY TO PAY THAT LOAN.  

By the numerous comments and questions we receive on all three of those posts it is obvious that many cosignors don't realize how serious this obligation is when they signed the loan.  Many people feel that it should matter that they don't have access to the collateral (such as a house or car) or that they don't have a relationship with the primary borrower anymore.  These are all the inherent risks in co-signing a loan and it doesn't matter to the lender.  If you cosigned a loan, you agreed to pay the money back if the other person doesn't, regardless of the circumstances.

If it isn't paid on time your credit will be affected.  If it isn't paid at all, the lender can sue you for the funds.  If the primary borrower files for bankruptcy and the debt is discharged so that they no longer owe it, you still do!

Cosigning a loan is not something that should be taken on lightly.  There are often good reasons to do it, but you should also consider all of the reasons why you might not want to.  In short, if you can't pay back the loan yourself, then you'd better be 100% positive that the primary borrower will pay it back.  If the lender was convinced of that, then the primary borrower wouldn't need a co-signor in the first place.

What to do when you receive a Notice of Bankruptcy? Step 4: What is your liability?

In our previous posts in this series you should have already identified why you received the Bankruptcy Notice and what the deadlines are that might apply to you.  In order to determine whether you should take any action related to this Notice, you now need to determine what you may have to lose.

If you are a creditor and you take no action, the debt owed to you may be discharged.  In most cases, there is nothing a creditor can do to prevent the discharge, especially in a no-asset case.  The right of the debtor to file for bankruptcy trumps your right to be paid by the debtor.  However, there are some examples where taking action can result in payment (or at least non-discharge of your debt).  Some examples where you may be able to prevent discharge of your debt, or all debts, is when the debtor committed fraud, when the debtor is trying to exempt property that should not be exempted, or when the debt is secured or otherwise protected from discharge (these are just some examples and is not intended to be an exhaustive list).

In any case where a creditor can prevent discharge, they are usually required to take some action to notify the court of their dispute and enforce their rights.  For example, in the case of fraud, the creditor must file an adversary proceeding challenging the discharge of that debt based on fraud.  In each individual case, you will have to determine if the value of preventing discharge of the debt is greater than the cost of enforcing that right.  In many such cases the creditor may reach settlement with the trustee regarding payment.

There are also situations where a bankruptcy may affect your liability, but there is nothing you can do about it.  For example, many codebtors will be affected by the bankruptcy of the debtor but have little rights to challenge the bankruptcy, because their liability is due to their own agreement with the creditor and they have no separately existing rights against the debtor.  This is often the case when one spouse, or ex-spouse files for bankruptcy.  Bankruptcy can have a major affect on debts owed by both spouses, and therefore property division, but if the divorce agreement doesn't appropriately address this possibility, the non-debtor spouse may have few or no options.  For more information about cosignors or the interplay of divorce and bankruptcy you may want to review these other posts:

I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?

I co-signed a loan and the primary borrower has filed for bankruptcy. What should I do to protect myself?

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #4: Jurisdiction over Your Assets

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #3: Jurisdiction over Your Debts

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #2: Domestic Support Obligations

4 Facts Your Divorce Attorney Should know about Bankruptcy? Fact #1: The Automatic Stay

Once you've identified your exposure in a bankruptcy, the last step is to determine if you need help in limiting that exposure.  Should you hire a bankruptcy attorney to help you evaluate your claims? 

What to do when you receive a Notice of Bankruptcy? Step 2: Are you a creditor?

If you receive a Notice of Bankruptcy you need to determine why you received the Notice. You might be a creditor, an interested party, or a codebtor.  Creditors are not the only ones who receive a bankruptcy notice, and even if you're not a creditor you may have an interest in what happens in this bankruptcy case.

The Notice will not tell you why you received it.  A sample notice, shown below, doesn't have your name anywhere on it.  It does, however, have the name of the debtor and the case number.  These two pieces of information should help you determine whether you are a creditor or some other interested party.

The Debtor, whose name is listed on our sample notice above as Sample Debtor, is the person who has asked the bankruptcy court for relief with their debts.  If you are aware of a debt that the debtor owes you then you are a creditor and you should review the other information within that Notice.  As a creditor you have certain rights that may include filing a Proof of Claim and attending the Meeting of Creditors.

If you're not sure if the debtor owes you money, then you might be a creditor or you might be something else, such as a contingent creditor, a co-debtor, or simply an interested party.  To determine why you received this Notice, you must look at the schedules.  The Bankruptcy court documents are public record and may be reviewed at the court or online if you have a Pacer access account.  If you need help accessing these files any bankruptcy attorney will have an online account access and be able to look up the case file online.

Once you have access to the file, you will want to review the Bankruptcy Petition and Schedules to figure out where your name appears.  If you are a creditor then your debt should be listed in one of the Schedules of Creditors.

If you are not a creditor you may still have an interest in the bankruptcy proceedings for some other reason.  For example a codebtor (someone who is also responsible for a debt that the debtor owes) could be left being wholly responsible for a debt if the debtor is discharged of that debt.  You might be a codebtor if you cosigned for a loan for the debtor, or if they cosigned for a loan that you took out, or if you borrowed money together for any reason (such as co-owners of a house with a mortgage).  Codebtors are listed on the Schedule of Codebtors.

If you are not a codebtor or a creditor then your name may still appear somewhere else in the schedules, identifying why you received the Notice.  For example, you may receive a Notice of Bankruptcy if you have a lease or other contract with the debtor, even if they are not behind on their payments.  Reading all of the schedules carefully should help you discover why you received the notice, whether you are a creditor, codebtor or some other interested party.

Once you identify why you received the Notice, you can begin to evaluate what type of action you should take.  For example the Notice tells creditors what many of their rights and obligations may be.  The next step, therefore, is to identify: What are the important dates and deadlines I should keep in mind?

I am the primary borrower on a loan and my cosigner has filed for bankruptcy. What should I do to protect myself?

A co-signer is an individual who is promising to repay a loan in the event the primary borrower defaults. In many cases, having a co-signer on a loan may have been necessary to obtain the loan because the primary borrower’s credit rating was insufficient to qualify on their own, and the co-signer stepped in to assist the primary borrower to obtain financing.

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.

I co-signed a loan and the primary borrower has filed for bankruptcy. What should I do to protect myself?

A co-signer is an individual who is promising to repay a loan in the event the primary borrower defaults. In many cases, having a co-signer on a loan may have been necessary to obtain the loan because the primary borrower’s credit rating was insufficient to qualify on their own, and the co-signer stepped in to assist the primary borrower to obtain financing without considering the long-term ramifications of that decision.

If the primary borrower defaults (or files bankruptcy), the co-signer will be required to pay the loan back. Additionally, unless the co-signer is also a “co-purchaser”, the co-signer is burdened only with the responsibility of repaying the debt and receives none of the benefit of the loan.

Consider the following 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. Adam files for bankruptcy, and surrenders (gives back the car to the lender) and obtains a discharge of the car loan. Betsy is still legally obligated to repay the unpaid balance of the loan, but does not get title to the car when she finally finishes paying off the car – which now belongs to the bank.

Being a co-signer can be extremely risky, and if the primary borrower files for bankruptcy, your credit can be affected. However, you can manage the credit damage by doing the following:

1. Determine whether the primary borrower intends to reaffirm the debt in bankruptcy court, (i.e., keep the car and continue paying the loan), or will surrender it back to the lender.

2. If the primary borrower is going to reaffirm the vehicle, ensure that they keep the payments current through bankruptcy, and sign the reaffirmation agreement.

3. If the primary borrower is not intending to reaffirm, or has already lost the vehicle due to repossession, the only way to protect your credit is to repay the loan pursuant to the terms of the agreement

4. Be aware that many loans include an acceleration clause, meaning that if one of the borrowers files bankruptcy, the entire balance of the loan is due. If the lender exercises their right to accelerate the loan, the co-signer may not be able to make regular monthly payments.

Remember, the decision to co-sign a loan is often made out of a desire to help a friend or family member, but it comes with significant legal consequences if they fail to repay. Consider any request to co-sign a loan carefully, and if the primary borrower 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.

What does it mean if someone listed me in their bankruptcy as a Co-Debtor?

When a joint obligor on a promissory note or other debt files for bankruptcy, the bankruptcy code requires that notice of the bankruptcy case is provided to the creditor and all co-debtors who are also obligated to pay the debt. If you receive notice that a co-borrower or co-debtor on a particular debt has filed for bankruptcy, it means that the debtor is complying with this particular requirement of the statute. In order for any actual or contingent obligation to be dischargable in bankruptcy, the creditor (the individual or business which is owed money by the debtor) must receive notice of the bankruptcy case, and have the right to object to the discharge of the debt, if appropriate legal grounds exist to object.

The reason that the code requires that all co-borrowers receive notice is because whenever there is a joint debt, the individual co-borrowers have “contingent, unliquidated claims” against all the other borrowers. Put another way, if Danny and Alice borrow $5,000.00 jointly, and Danny doesn’t pay , the lender can sue Alice and force her to repay all of the $5,000.00. Alice can then sue Danny and force him to contribute to the payment of the judgment obtained against Alice. However, in the event Danny files for bankruptcy, neither the original lender, nor Alice can sue Danny in an attempt to collect the balance even if the lender seeks to collect against Alice.

In this case, Alice would be best served to speak to a bankruptcy attorney, because she has a very limited time to do what she can to protect her claim, if anything. Alice’s right to collect any money from Danny is very fact specific, and the whole story will determine whether Danny’s “contingent” debt to Alice can similarly be discharged. If you find yourself owing a joint debt with someone who has recently filed for bankruptcy , contact Attorney Matthew P. Trask to discuss your rights and obligations.

To read more about co-debtors and bankruptcy, see our post What happens to my Cosigner if I file for Bankruptcy.