Impact of Co-Signer Bankruptcy on Auto Loan Applications and Credit Scores

When considering an auto loan, one of the key determinants in the approval process is the existence of a co-signer. A co-signer agrees to repay the loan if the primary borrower defaults. However, if a co-signer files for bankruptcy, this can have significant implications for the co-borrower's chances of obtaining a loan and the impact on credit scores.

Chapter 7 and Chapter 13: Impact on Co-Signers in Bankruptcy

The consequences of a co-signer filing for bankruptcy depend largely on the specific chapter under which the bankruptcy is filed (Chapter 7 or Chapter 13).

Chapter 7: Minimal Protection for Co-Signers

Under Chapter 7, the automatic stay applies to the co-borrower but not to the co-signer. Creditors can pursue the co-signer for collection immediately following a loan default. This means that the co-signer may be held responsible for the debt, regardless of the primary borrower's bankruptcy filing.

Creditors' Actions:

Bankruptcy does not affect the co-signer's liability for the debtholder does not have to be notified that a payment is missed. The co-signer can still be pursued even if the primary borrower makes timely payments. The creditor might seek a reaffirmation agreement, making the co-signer responsible for the debt in the future.

Chapter 13: Greater Protection for Co-Borrowers

Under Chapter 13, co-borrowers have more significant protection. If a co-signer agrees to continue making payments throughout the bankruptcy, their credit score is generally unaffected. The co-borrower receives the benefit of a “co-debtor stay,” which prevents creditors from pursuing the co-signer for collection.

However, if the Chapter 13 plan is incomplete, creditors might request the stay be lifted, allowing collection efforts to resume.

Impact on Credit Scores

The primary borrower's bankruptcy filing will impact their credit score, typically causing it to drop by 100 to 300 points. However, the co-borrower's credit score may be protected as long as the loan is paid on time. Credit bureaus see the cosigned debt as belonging to both parties, so even if the primary borrower misses payments, both the primary borrower and co-signer will suffer credit score losses.

Steps to Protect Credit Scores:

Notify the co-signer of missed payments so they can take action if necessary. Keep communications open with the co-signer to ensure timely payments. Avoid defaulting on the loan, as both parties can be held legally responsible.

In conclusion, while co-signing an auto loan is a financial risk due to the potential bankruptcy of the co-signer, staying informed and proactive can help mitigate the negative impact on both the primary borrower and the co-signer.