What Happens to My Cosigner if I File Chapter 13 Bankruptcy

If you have a Chapter 13 bankruptcy and you have debt with a cosigner, your bankruptcy could affect the cosigner. But first, let's talk a bit about some bankruptcy basics to help you better understand how they affect you (the debtor) and your cosigner.

(To learn how Chapter 13 bankruptcy works, what the repayment plan is, and how your debts are generally treated, see Chapter 13 bankruptcy.)

Codebtors and Cosigners Defined

The person who files bankruptcy is called the debtor. Any person who cosigns a loan with the debtor is called a cosigner. When the debtor files bankruptcy, an automatic stay goes into effect that prevents most creditors from taking any action to collect their debts.

(To learn more, see Bankruptcy's Automatic Stay.)

When just one person has signed on a loan, the automatic stay applies only to that debtor and the debtor's property. But when the debtor has a cosigner on a debt, filing a Chapter 13 bankruptcy will also protect the cosigner from collection actions by the creditor. This protection is called the codebtor stay. The codebtor stay continues until the bankruptcy case is over, unless the court lifts the stay at the creditor's insistence (which must be for cause – see below). The codebtor stay is a very nice perk and, in fact, motivates some debtors to file Chapter 13 even when they qualify for Chapter 7.

Who and What Qualifies for the Codebtor Stay?

To qualify for the codebtor stay, the cosigner must be an individual person. The cosigner cannot be a business entity or an individual who cosigns for their spouse's debt incurred as part of the spouse's business. The debt cosigned must be a consumer debt -- that is, a debt incurred primarily for personal or family purposes and not a business debt.

Example 1. Joe wants to take out a business loan, but his credit score is too low, so his mother cosigns the loan for him. Six months later, Joe files Chapter 13 bankruptcy. The codebtor stay does not apply because the debt is not consumer debt. Therefore, the lender can try to collect the debt from Joe's mother even though Joe is in bankruptcy.

Example 2. Amanda's father cosigned her first credit card. She used it to buy food, gas, clothing, and books for school. She filed Chapter 13 bankruptcy. The codebtor stay applies to Amanda's father, because the debt is consumer debt (not for business purposes) and her father is an individual.

Can the Creditor Challenge the Chapter 13 Codebtor Stay?

When the codebtor stay applies, the creditor can ask the court to lift the stay in certain situations. The creditor files a motion with the court, and the debtor and codebtor can respond. The creditor can ask the court to lift the codebtor stay if:

• the cosigner received the benefit of the debt instead of the debtor,
• the Chapter 13 bankruptcy repayment plan does not provide for repayment of the debt, or
• the creditor's interests would be harmed beyond repair if the stay were kept in place.

Example 1. Dan takes out a car loan, and his brother Ken cosigns on the loan. Ken drives the car, not Dan. The lender will file a motion to lift the codebtor stay to collect against Ken, because he received the property the loan was used to purchase.

Example 2. As in the previous scenario, Dan takes out a car loan, and his brother Ken cosigns the loan. Later, Dan files Chapter 13 bankruptcy. Dan's Chapter 13 plan does not propose to repay the car loan. The creditor can ask the court to lift the codebtor stay.

Example 3. Again, Dan takes out a car loan and his brother Ken cosigns on the loan. Dan files Chapter 13, but six months into his plan, he stops making his payments, and the creditor is not getting paid. The car is rapidly depreciating in value. The creditor can file a motion to lift the codebtor stay to protect its interest in the car.

The Codebtor Stay is a Major Incentive in Favor of Chapter 13

The codebtor stay provides a major incentive for debtors to file Chapter 13 rather than Chapter 7, which does not have a codebtor protective stay. Even though many debtors might qualify for Chapter 7, those with cosigners will file a Chapter 13 case just for the benefit of the codebtor stay.

Unfortunately, a Chapter 13 case is not always an option. Chapter 13 might not be available to debtors who have previously filed bankruptcy, debtors whose total debt exceeds a certain amount, debtors who are unemployed and have no other regular source of income, or when the debtor is not capable of making the payments to fund a Chapter 13 plan. Consult a qualified bankruptcy attorney, who can help you determine if a Chapter 13 is feasible.

After the Chapter 13 Bankruptcy is Discharged or Dismissed

Once the bankruptcy is over, the automatic stay and the codebtor stay are both lifted. A debtor who obtains a discharge is no longer responsible for the discharged debt, even if a balance remains. Of course, not all debt is dischargeable. The debt is not discharged as to the cosigner. Most of the time, the debt will be paid in full during the Chapter 13 plan. For instance, if child support debt is not paid in full during the Chapter 13 case, the creditor can collect on the debt from the cosigner.

If the case is dismissed without completing the Chapter 13 plan, both the regular automatic stay and the codebtor stay will be lifted and the creditor will be free to seek payment from either the debtor, the cosigner, or both.

Example 1. Tom completed a Chapter 13 bankruptcy and received a discharge; however, he was not able to discharge his student loan because he could not prove hardship. After the bankruptcy closed, Tom and his father Frank are each responsible for the remaining balance of the student loan.

Example 2. Jane filed Chapter 13 bankruptcy and was paying for her car through the plan. Her friend Donna is a cosigner on the loan. Jane is protected by the automatic stay and Donna is protected by the codebtor stay. After paying into her plan for two years, Jane decides she no longer wants to be in a Chapter 13 and voluntarily dismisses her case, losing the benefit of the automatic stay. Once the case is closed, the codebtor stay is lifted and both Jane and Donna are responsible for the remaining balance of the car loan.

(To learn more about how debts are treated in Chapter 13 bankruptcy, see the articles in Your Debts in Chapter 13 Bankruptcy.)