How Will My Bankruptcy Affect the Cosigner?

If your debt situation has become truly unmanageable, you may be able to reduce or eliminate many of your unsecured obligations by declaring bankruptcy. With just a few exceptions, bankruptcy obliterates common debts like credit card balances, medical bills, and judgments arising from lawsuits brought by your creditors. Cosigned debts are a different story: If you've enlisted a third-party cosigner to act as a backstop for your debts, they may be forced to pony up for your financial recklessness.

An unsecured debt lacks any connection to a tangible asset that can be seized in the event that its holder becomes unable to continue making regular payments on it. Unsecured debts are inherently riskier than secured debts, and unsecured creditors lack many of the basic protections afforded to their secured counterparts by the bankruptcy process. For this reason, unsecured creditors commonly require risky borrowers to find cosigners with solid credit ratings to guarantee their loans. In effect, these cosigners provide the "security" that's missing from a regular unsecured loan.

Folks who cosign for borrowers teetering on the edge of insolvency may come to regret their generosity. When you file for bankruptcy, your cosigner legally becomes a "co-debtor" who must cover the outstanding balance on the debt that they agreed to guarantee. If they don't have the funds to do so, your lender may harass and penalize them for their intransigence. Depending upon the size of the loan, they may be on the hook for thousands of dollars. In the worst-case scenario, their decision to become your cosigner could damage their finances so badly that they'd be forced to declare bankruptcy themselves.

To afford your cosigner some protection from your creditors, consider filing for Chapter 13 bankruptcy. In many cases, the Chapter 13 process automatically discharges cosigned consumer debts. If the cosigned loan wasn't being used to fund your business activities, your cosigner probably won't be liable for it. In all likelihood, you'll both be able to walk away from the obligation without incurring further financial losses.

There is one major exception to this general rule: Your cosigner will be held to account for all debts that aren't included in the repayment plan brokered by your bankruptcy judge. Such debts are typically small and unsecured, so they may not ruin your cosigner's finances in the event that their issuers demand repayment. Still, you'll want to make sure that they're not overlooked.

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