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Updated: Mar 14, 2024

What to Do If You've Cosigned for a Loan and the Borrower Goes Bankrupt

Have you cosigned for someone who is facing bankruptcy? Find out what to do when a cosigned loan borrower goes bankrupt.
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When most people hear the word "bankruptcy," the term often connotes a worst-case scenario.

Indeed, no one wants to find themselves in a position where they may have to embrace bankruptcy, but sometimes it's the only option that will help someone to get back on their feet.

What this doesn't take into consideration is the third-party; in this case, a cosigner.

Bankruptcy and Cosigning

Let's say you find yourself in a situation where you've cosigned on an auto loan for a friend or family member and, later, they decide to file bankruptcy.

There's no getting around the fact that you'd most likely be worried in such a scenario, and for good reason.

Depending upon the circumstances, you may end up being liable for the remaining balance of the loan if this were to occur, and the question of whether or not it could end up affecting your credit will most likely haunt you.

The thing is, a number of different factors can play into how cosigning on a loan for someone who turns to bankruptcy might affect you.

For example, the outcome will be different if the individual chooses Chapter 7 over another option.

Court orders will be different for everyone, as no two situations are alike when it comes to bankruptcy.

It can seem as if getting a straight answer as to how cosigning on such a loan might affect your financial situation is next to impossible, but there are things that you can do.

Approaching the Situation With Care

The most important thing to remember when you're dealing with a potentially disastrous cosigning scenario is to not make any mistakes that could come back to bite you in the foot.

Many people panic and turn towards making rush decisions, which, more often than not turn out to be bad ideas.

Instead, there are a few things that you should do as soon as to possible to ensure that you are handling the situation properly.

Consult an Attorney

For one, the first thing you should do is speak to a lawyer who specializes in bankruptcy.

Many people don't want to pay excessive lawyer fees if they don't have to, and for good reason.

To that point, however, spending a couple hundred dollars in order to save thousands may not be the worst idea you've ever made, especially if the loan you've cosigned has a large balance remaining.

A lawyer can help you to determine how much the situation may impact you financially and what steps you might need to take in order to keep large problems at bay.

If you want to get the most accurate answers possible, however, you're going to need to know what the person declaring bankruptcy plans to do.

Don't Freak Out

Sit down with the person who has taken out the loan and try to pull together a few facts.

For one, determine what type of bankruptcy they're planning to file, as this can have a huge impact on what results in the end.

Chapter 7, 11 and 13 all have different outcomes, and whether or not you end up being involved is something that can rest on the type of bankruptcy being filed.

Also, see if you can get a timeline as to when the person is planning to file, as this will give you the time you need to make the right decision in terms of what steps will help to get you out of potential trouble.

Get the Details of What's Happening Now

Finally, you'll want to get a detailed report of what is currently going on with the loan to bring to a lawyer so that he or she can have as much information about the situation as possible before determining which approach needs to be taken.

You should know exactly how much is left of the remaining balance on the loan, whether or not any payments have been missed and what your responsibilities as a cosigner are.

Providing this information to the attorney you choose to work with (should you need to) is essential to avoiding any mistakes that could get in the way, and it doesn't have to take up a lot of your time.

Perhaps most important, you should take a moment to sit down with the individual who is going to file bankruptcy and discuss the situation and how they got there in the first place.

It's helpful to know as much as possible about the situation so that you can speak about it in an educated manner.

This can be an uncomfortable conversation to make, but it's necessary.

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The Good and the Bad

Cosigning is one of those things that is often considered to be a double-edged sword.

On one hand, many people can be helped dramatically by the process of cosigning in terms of getting a loan, and it can really make a difference in one's life.

At the same time, the cosigner gains very few benefits from signing on the dotted line, yet the potential problems they can end up running into are undeniable.

Cosigning, then, is one of the riskiest financial decisions an individual can make, and the idea is usually not worth entertaining.

Nevertheless, many people find themselves in a situation where they'd like to help out someone who is close to them and will take the risk of cosigning.

In this case, it's important to take into consideration all of the different factors that can get in the way and cause problems.

Bankruptcy, for example, is often overlooked as a potential roadblock that could derail a cosigned loan, and the problems that can result are quite real for all parties involved.

In the end, cosigning on a loan is rarely a good idea, but if you find yourself in a situation where you need to, you'll want to ensure that you're as protected as possible.

Work with a lawyer, and chances are you'll be able to diffuse the situation.