25 Jun Friends & Family Cosigned For You? A Bankruptcy Trap for the Unwary.
Having a co-signer is a good way to get more credit. It’s a special issue when you are filing bankruptcy, though. There are a lot of ways to address these debts but you have to be careful.
A co-signer is often helpful in getting more credit or better terms on loans. After all, the bank has another warm body to go after if you don’t pay. When that happens, obviously you feel more strongly about protecting your friend or family member who co-signed for you. When things are tough, we look out for our own.
There are special issues that can come up in this situation though. First, it is very important that your lawyer knows a debt is co-signed. There are a lot of special issues and disclosure requirements in that situation. And your co-signer has a right to know you filed bankruptcy — because they are a creditor of yours too (you said you’d pay the debt and now you might not).
But there are other issues. Your bankruptcy discharge will not typically wipe out the obligation of your co-signer. So they are still obligated to pay the account if you don’t. Of course, sometimes you can use bankruptcy to get rid of the other debt so you can focus on repaying the co-signed debt — even if you wiped out your legal obligation already.
In other situations, a Chapter 13 payment plan may allow you to pay the co-signed bill in full while paying little or nothing to other unsecured creditors. This can vary depending on your district but, if yours allows this, it can help assure your co-signer does not have to pay your debt off. And Chapter 13 provides a special co-debtor stay — similar to the automatic stay — which protects your co-signer like you from collection efforts while the plan is going forward.
Another critical issue is how that debt was being paid prior to bankruptcy. If the court considers your co-signer an “insider” then a bankruptcy trustee might be empowered to get money from them — as a preference (a preferred treatment over other creditors). But, you say, I did not pay them a penny, I just paid the loan to the bank! That’s right. And the trustee could go take back payments to the bank made during the 90-days prior to filing. But she can also go after you co-signer for a year’s worth of payments — because you “preferred” your co-signer by paying their debt while not paying so much of your other bills.
You see, part of bankruptcy is recovering any excessive benefit received by creditors who have special leverage over you — leverage that might (intentionally or not) result in you not paying everyone else as well and, ultimately, causing everyone a loss.
At least that’s the theory. In practice, in the average consumer case, it’s just a land mine for the unwary. Typically we recommend folks hold off on filing until the repayment in the last year is small enough not to interest a trustee — but this also means your co-signer needs to take up paying the debt at least until you get your case filed filed.
The important thing here is to be sure your attorney knows about the co-signer on any of your debt and knows if you have been paying that bill, and how much, in the last year. And be prepared to work with him and your co-signer to get everyone through the process. It’s like any team project — If everyone works together then no one gets hurt!
Photo credit: Flickr/Victor1558
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