Usually, a creditor can collect a debt from you, the cosigner, unless the main borrower agrees to repay the creditor in the bankruptcy court. This could have a negative effect on your credit rating. You should get a lawyer immediately after you're informed of the bankruptcy to learn how it affects your credit. Assuming that your credit is impaired as a cosigner, the bankruptcy will certainly not be helpful when applying for refinancing.
Cosigner Bankruptcy Obligations
Filing a bankruptcy case will not eliminate the liability of any co-signers for loans owed by the person filing bankruptcy. Bankruptcy does, however, relieve the person filing from further legal obligations to pay the debts. Because the creditor cannot collect the legal debt from the bankrupt filer, you can expect the creditor to make every effort to collect from you as the cosigner. If you do not want this situation to impair your credit standing, you have no alternative but to pay the creditor. If the situation results in derogatory comments about the bankruptcy on your credit report, lenders may burden you as the cosigner with the same requirements as the bankrupt filer when applying to refinance a mortgage.
Refinancing After a Bankruptcy
About 95 percent of all mortgages being written today are sold to Fannie Mae or Freddie Mac, or insured by the Federal Housing Administration. These agencies set the rules that lenders execute. Fannie Mae and Freddie Mac have identical waiting periods before a borrower becomes eligible for a mortgage or refinance: Two years after a Chapter 13 bankruptcy and four years after a Chapter 7 bankruptcy. Chapter 13 is "debtor's court" where you reschedule your debt payments under court supervision. Chapter 7 is complete liquidation of assets to pay off outstanding debts. The FHA has a waiting period of two years before a borrower can obtain an FHA mortgage refinance after a Chapter 7 filing and one year after a Chapter 13 filing.
Letter of Extenuating Circumstances
Regardless of whether lenders abide by Fannie Mae/Freddie Mac guidelines or FHA guidelines, they all require a Letter of Extenuating Circumstances from a borrower explaining derogatory comments on the borrower's credit report. The letter is precisely for the purpose of giving you, the borrower, the opportunity to explain why the negative comments are not really reflective of your credit worthiness and why they should be ignored, or minimized. This letter is most appropriate for a person fallen victim to bad credit due to a third party filing bankruptcy and sticking you with the bills as the cosigner. Of course, there are no guarantees that the letter will work, but it's certainly worth pursuing if you intend to refinance sooner than later.
Talk to a Loan Officer
Should you decide to equip yourself with a letter in response to bad credit resulting from cosigning a debt; it might be productive to meet with a loan officer at your bank for advice. Most loan officers are sympathetic to borrower credit issues. Because loan officers are knowledgeable of what their underwriters require in terms of cry letter content, many will even help you write the letter.
- The Law Offices of Rick D. Banks: Does Bankruptcy Affect Cosigner's Obligations?
- FannieMae: Bankruptcy, Foreclosure, and Conversion of Principal Residence Policy Changes; and Revised Property Value Representation and Warranty Requirements
- BankRate.com: Rules for refinancing after bankruptcy
- FHA.com: FHA Requirements: Credit Guidelines
- CREFCO: Bankruptcy Options with FHA
- The Mortgage Professor: How Forgiving Is the Mortgage System?
- Creatas/Creatas/Getty Images
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- What Happens After Completing a Chapter 13 Bankruptcy?
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