When you apply for a loan, lenders often require a cosigner if they have concerns about your ability to pay them back, regardless of the amount. Personal guarantees are usually necessary for those starting a business.
While having a cosigner can help you secure a loan, it also places them at risk. If you file for bankruptcy, they might still be responsible for the debt, depending on the type of bankruptcy filed. This can be especially troubling if your cosigner is a trusted family member or friend.
Why do some creditors require a cosigner?
Lenders sometimes want added assurances that a loan is repaid. Typical reasons include:
- You have a limited credit history
- Your credit report shows issues, such as late payments or bankruptcy
- You’re unable to provide collateral
- You need to borrow an amount beyond your repayment ability
- You’re borrowing money for business purposes
If you cannot repay the loan or must file for bankruptcy, lenders will also hold your cosigner responsible because they’ve already agreed to fulfill the loan terms if you default.
The type of bankruptcy protection matters
If you file for bankruptcy, whether your cosigner must pay your debt depends on the type. Here’s how it works:
- Chapter 7: Your cosigner receives no protection. Creditors can still pursue them for the debt.
- Chapter 13: Offers more protection. The automatic stay can temporarily prevent creditors from pursuing your cosigner.
Understanding these differences is crucial as it determines how much risk your cosigner faces, including damaging their credit.
Steps to protect your cosigner
It’s essential to shield your cosigner from having to pay your debt. Here are some actions you can take:
- Reaffirm the debt: Agree to continue paying a specific debt, removing it from the bankruptcy discharge.
- Pay off the debt: Repay the debt post-bankruptcy to relieve your cosigner.
- Convert to Chapter 13: Consider filing Chapter 13 if you initially filed Chapter 7 for better cosigner protection.
Understanding the potential liabilities of cosigning a loan is vital. Consider consulting a knowledgeable bankruptcy attorney before agreeing to cosign or asking someone to do so. A skilled lawyer can provide guidance to help avoid or minimize negative consequences for both parties.