Is co-signer at risk if bankruptcy looms?

Opening Credits columnist Eric Sandberg
Erica Sandberg is a prominent personal finance authority and author of "Expecting Money: The Essential Financial Plan for New and Growing Families." She writes "Opening Credits," a weekly reader Q&A column about issues for people who are new to credit, for

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Question for the expert Dear Opening Credits,
My daughter is filing for bankruptcy and I have co-signed on a private student loan for her. How will this affect me? -- Nancy 

Answer for the expert Dear Nancy,
Your letter serves as an important reminder that it is usually best to not co-sign on a loan or credit line. While these types of arrangements can work out just fine, a negative outcome is always a possibility. We simply can't control other people's actions or circumstances, making joint ownership inherently risky.

Had you known that your daughter would get into financial trouble -- and then have to declare bankruptcy to get out of it -- you probably would not have linked your name with hers by guaranteeing the student loan. But you did, and now have to worry about the implications.

Since it would be highly unlikely that your daughter would be able to include the student loan in the bankruptcy, the balance of it would remain. But how does the discharge of other debts affect you as a loan co-signer to the one that was left out? Not much. However, to be absolutely sure of the legal implications, I took your question to my bankruptcy expert, San Francisco attorney Jeena Cho, and asked her to give you her professional opinion.

"Your daughter will still be responsible for the student loan after the bankruptcy. You'll also be responsible as a co-signer. So, basically, your responsibility won't change because of your daughter's bankruptcy. If she defaults, the lender may pursue you for payment," says Cho.

The last line is a little ominous, though, isn't it? If your daughter doesn't satisfy the loan as specified in the contract and then defaults, the bank has every right to come after her as well as you for the delinquent debt. Then again, that's been the case from the moment you signed the original documents.

And that's the main reason that I am generally opposed to people merging their credit. Helping your child finance a college degree in this way is a lovely gesture, but there are consequences to consider. The far better option would have been for you to save and invest for the expense, then sent the school cash for the tuition. Or she could have paid for her own education. Many students do.

Still, not all is gloom and doom. While bankruptcy is a serious step that comes with some profound negative consequences (for example, your daughter will have to contend with the realization that she might have mishandled her financial affairs, live with the notation on her credit reports for a decade and borrow money at poor lending terms for quite some time), she will also be relieved of her unsecured debts. This could put her in a position where she has enough money left over in her household budget to cover her other obligations -- including the one to which you are legally linked.

Meanwhile, there is no out for you now. The two of you are in this loan together until the end, so remain in constant communication. Make sure she's handling it the way she should by talking to her about it, checking with the bank and keeping an eye on your credit report for evidence of missed payments. You'll want to catch problems in the very early stages, because if they go on too long, you'll be hearing from the lender -- and your credit as well as your daughter's will certainly suffer.

See related: Steps to make good on a defaulted student loan, How to move student loans out of default

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Updated: 12-12-2018