If you have a cosigner on a consumer (nonbusiness) debt and you want to file for bankruptcy relief, you might be able to protect the cosigner with Chapter 13 bankruptcy's codebtor stay. Read on to learn more about protecting cosigners with Chapter 13 bankruptcy.
When a borrower doesn't have much in the way of income or solid credit history, many lenders require another person to agree to be responsible for the loan if the borrower can't pay. Lenders typically call this person a "cosigner" because they agree to sign the contract with the borrower. Essentially, a cosigner is another person who is liable for the loan.
Cosigners are responsible for paying back the debt, just like the primary borrower. If the borrower defaults, the lender can go after both the borrower and the cosigner to collect the debt. In bankruptcy, a cosigner is also known as a "codebtor."
One of the benefits of filing for bankruptcy is that the moment you file, the automatic stay prevents creditors from collecting most debts from you (unless you've recently filed multiple bankruptcy cases). But that's not always the case in bankruptcy.
In a Chapter 7 case, the automatic stay applies to the debtor only. A cosigner will remain liable for the obligation even if the discharge will wipe out your liability for all qualifying debts. The discharge does not eliminate your cosigners' liability. They will remain on the hook for paying back your debt.
If you want to protect your cosigners, you can do so by paying off the debt through a Chapter 13 repayment plan. Unlike Chapter 7 bankruptcy, your cosigners are protected to a certain extent by the Chapter 13 codebtor stay (discussed below). And, if you're able to repay the debt through your plan in full, nothing will be left to collect from the cosigner once the Chapter 13 case ends.
This approach works well with car loans because, in most cases, the time left on the contract will be less than five years and the loan would get repaid in full. A debtor who qualified for a three-year plan could extend the plan period to five years, if necessary.
However, this approach might not work for all debts. Specifically, you might run into a problem if you propose paying more toward the cosigned debt than it would usually be entitled to receive. Why? Because unless you're paying all of your debts in full—not just the cosigned debt—it's likely that other creditors would receive less than what they'd be entitled to get otherwise.
Example. Suppose that you have three credit card balances of $10,000 each, and a disposable income of $15,000 to be paid over the life of your plan. Credit card balances are unsecured debt, so Chapter 13 creditors share disposable income on a pro-rata basis. Usually, that would be $5,000 each. If, however, you propose paying the cosigned debt $10,000, you'd likely get objections from the creditors slated to receive only $2,500.
Keep reading to learn more about how this works and other limitations.
In Chapter 13 bankruptcy, the automatic stay protects your cosigners from creditors unless:
Creditors cannot collect from your cosigners as long as the codebtor stay remains in effect. It's assumed that the debtor might fully repay the debt through Chapter 13 bankruptcy, in which case it would be unfair to allow the creditor to receive payment from two sources.
However, be aware that the codebtor stay has its limitations. Creditors have grounds to ask the court to lift the codebtor stay if:
Chapter 13 cases have many issues to address—some of which can conflict. Given the complicated nature of Chapter 13, it's strongly suggested that you seek the advice of a bankruptcy lawyer. Learn more about when it's best to hire a bankruptcy lawyer and how to find one, as well as the differences between Chapter 7 and 13 so that you can choose the best bankruptcy chapter for you.