What Will Happen If the Cosigner of Your Loan Files Bankruptcy?

Written by James Hirby | Fact checked by The Law Dictionary staff |  

The prospect of building your credit with a cosigned car, home or personal loan is exciting. Your first big loan is a major milestone on your road to financial adulthood and can make or break your reputation in the eyes of future lenders. You may be so ginned up by the thought of finally owning something on credit that you fail to consider a problematic contingency: your cosigner's insolvency.

Although lenders usually require folks who cosign a loan to have good credit, they sometimes make ill-advised exceptions to their stringent lending standards. Cosigners with poor or mediocre credit may fall through the cracks and be permitted to sign for loans that they can't possibly cover.

Even if your cosigner's finances are in order when they sign for your loan, the turbulent economy offers no guarantee that they won't deteriorate over the long course of its life. After all, no amount of credit-checking or financial disclosures can uncover a problem that hasn't yet developed.

The effect of your cosigner's bankruptcy on the status of your loan and your own solvency will vary according to the strength of your personal finances. Legally, your cosigner's bankruptcy filing wipes out their obligation to cover your loan in the event that you can't continue to make your payments. If they were providing you with funds to help you stay current on your loan, you may need to dig deep to remain in good standing with your lender.

If you weren't relying on your cosigner for financial support and can continue to make your monthly loan payments without a problem, you'll see no practical change in your credit score or day-to-day financial health. As a rule, you should never use a cosigner as a crutch to take out a loan that you can't afford. Your cosigner exists to assuage your lender's concerns about your mediocre credit rating and modest income, not to provide you with a monthly allowance.

Your cosigner's bankruptcy filing will unnerve your lender. To pacify them, send them a notarized letter that reaffirms your commitment to pay off the balance of your loan on time and in full. If possible, do this before they even learn of your cosigner's misfortune. You may also offer to put up more collateral for a secured loan. While you're under no legal obligation to do this, it may encourage your lender to lower your interest rate.

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