What to Do If a Co-signer Files for Bankruptcy

Co-signing on a loan or a credit card certainly has its risks, as people with good credit who offer to put themselves on the line for a friend or family member are often told. But what happens if the person who extends their credit profile to someone with no credit or bad credit then has their own money troubles?

One Credit.com commenter is dealing with this very scenario.

“My father co-signed my private student loans and filed bankruptcy without my knowing,” Marie writes. “When I went to pay as I always did, it read ‘default: reason bankruptcy.’ I was told my loan was sent to another company and they would contact me. I never heard from them. I called them recently and they won’t give me any answers. Just said they are unable to discuss my account until the bankruptcy is settled.”

Her credit score appears to have plummeted as a result. “I’m terrified because I don’t know what I’m facing,” she wrote. “Should I contact a lawyer to protect me?”

What Is Happening?

Creditors will often call an entire loan due once a borrower files for bankruptcy in an attempt to collect on the account before or during the process. This move can result in a freeze on the account, affecting a person’s ability to make payments, or a note on the borrower’s credit report, indicating that the account has entered default as a result of bankruptcy.

How any co-signers can be affected by this action depends largely on what type of bankruptcy was filed, said Ed Boltz, president of the National Association of Consumer Bankruptcy Attorneys. A Chapter 13 bankuptcy, which allows an indvidual to create a repayment plan, “specifically provides for protection of a co-debtor and provides against creditors damaging a co-debtor,” he said, so if your co-signer went this route and you’re being barred from making payments, you may have a legal claim.

It gets a bit murkier when it comes to Chapter 7 (straight bankruptcies) and Chapter 11 (typically reserved for businesses), since protection of third-party guarantors is not always allowed. Still, state laws vary. In some parts of the country, for instance, lenders may be prohibited from calling the entire loan due, Boltz said. In either case, it may be in your best interest to consult a consumer law attorney to see if you have any legal recourse.

“Because it is complicated, some creditors decide to take what they consider to be the safest approach and refuse all contact and payment, regardless of the Chapter or plan,” he said. “I consider this improper, a breach of contract and an unfair trade and deceptive trade practice.”

(As a side note, in Marie’s case, the lender’s decision to call the note due and bar payments is perhaps futile, given student loans, by and large, cannot be discharged in bankruptcy, no matter what type of was filed.)

Keeping Your Credit Intact

The other thing you should do if a co-signer files for bankruptcy is monitor your credit. (You can pull your free annual credit reports at AnnualCreditReport.com and get your credit scores for free each month at Credit.com.) If the bankruptcy appears and subsequently affects your score, you can file a dispute with the credit bureau to have it removed.

“Neither the bankruptcy public record or the bankruptcy account status should appear in the co-signer’s credit report,” Rod Griffin, director of public education for the credit bureau Experian, said in an email. “If the account is showing a status of included in bankruptcy, the co-signer should dispute the status and indicate that they did not declare bankruptcy. If there is no bankruptcy public record in the report, we should be able to remove the account’s bankruptcy status.”

(Note: a lender who is blocking payments on an account may continue to report a bankruptcy each time they update the credit bureaus of its status, so, again, you may want to consult an attorney to see what recourse you have to keep your credit report clean.)