Bankruptcy

Bankruptcy & Car Loans: Reaffirmation and Co-Signer Risk

By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).

When a debtor files for bankruptcy, one common issue is the car loan. Is the debtor keeping the vehicle or surrendering it? If the debtor is keeping the car, the lender may require that the debtor sign a reaffirmation agreement. Let’s review what a reaffirmation agreement is and how it affects co-borrowers and co-signers.

Updated on October 5, 2024.

What is a Reaffirmation Agreement?

When a debtor files for bankruptcy and has secured debt, such as a car loan, they generally have two primary options for the vehicle:

  1. Keep the car: The debtor continues to make monthly payments and must, in most cases, sign a reaffirmation agreement.
  2. Surrender the car: The debtor gives the vehicle back to the lender, and the debt is discharged in bankruptcy.

Lenders often require a separate agreement, known as the reaffirmation agreement, to confirm the debtor is keeping the debt and not discharging it in bankruptcy. This agreement ensures the debt remains legally enforceable against the debtor personally, even after the bankruptcy is finalized.

By signing the reaffirmation agreement, the debt cannot be discharged under 11 U.S.C. § 524(c) of the Bankruptcy Code. This is a critical point that, in my experience, debtors often overlook: Once the car loan has been reaffirmed, you are still personally liable for the full amount of the debt.

Once signed by all parties, the reaffirmation agreement is filed with the court along with a motion (Official Form 2400B). The judge then signs the Order approving the reaffirmation agreement (Official Bankruptcy Form 2400C) before the Order of Discharge is entered. This judicial review is in place to protect the debtor from reaffirming a debt that would create an undue hardship.

Professor’s Note: While rare, a reaffirmation agreement can theoretically apply to unsecured debt like credit cards, but for vehicles, it is a very common requirement imposed by secured creditors.

How Bankruptcy and the Reaffirmation Agreement Affect Co-borrowers and Co-signers

In my years both practicing and publishing in the field of consumer bankruptcy, one of the most significant and complex issues debtors and cosigners face is the financial impact of a co-signed loan.

What is a Co-borrower and Co-signer?

Co-borrower (Joint Applicant): Both parties typically share ownership of the car and assume equal, joint responsibility for the monthly car loan payments. A common example is a married couple.

Co-signer: The co-signer is usually not involved in the ownership of the car but is fully liable for the loan if the primary borrower fails to make the monthly payments. A common scenario is a parent co-signing for an adult child to secure a lower interest rate based on the parent’s stronger credit.

    What are the Risks Involved for Co-borrowers and Co-signers?

    Whether there is a co-borrower or a co-signer, the legal and financial risk is the same for everyone involved. If payments are late, the credit score for both the primary borrower and the co-borrower/co-signer is negatively impacted.

    The biggest risk, however, occurs if the payments stop altogether.

    What Happens to Co-borrowers and Co-Signers When the Car Payments Stop?

    When payments stop, the creditor has the legal right to sue the debtor. Since this is a car loan, the creditor can first repossess and typically sell the car at auction.

    Most debtors mistakenly believe that once the car is gone, their obligation ends. This is not true. If the auction price is less than the remaining loan balance, the lender is left with a deficiency. A deficiency is when the outstanding balance left on the loan after the car has been sold.

    Example: A debtor has a $20,000 car loan. The bank repossessed and sold it at auction for $15,000. There is a $5,000 deficiency.

    The lender can pursue a deficiency judgment for that $5,000. This judgment is a court order that can result in serious collection actions, including:

    • Wage garnishment
    • Freezing bank accounts
    • Placing liens on property

    As I often explain to my students and clients, the car loan is simply a contract. The original promise was to pay back $20,000. If only $15,000 is recovered, the contract has been breached, and the debtor still legally owes the difference.

    The Debtor files for Bankruptcy, and the Co-borrower or Co-signer is Being Sued

    What happens if the primary debtor files for bankruptcy and includes that $5,000 deficiency judgment?

    1. For the Debtor: Assuming the bankruptcy is approved (discharged), the debtor is no longer legally responsible for the car loan or the deficiency judgment.
    2. For the Co-borrower/Co-signer: The legal responsibility for the debt shifts entirely to the co-borrower or co-signer.

    As this is a breach of a contract signed by two parties, the debtor’s bankruptcy only eliminates their liability. The co-signer now faces the same difficult choices the primary debtor did: either file their own bankruptcy to eliminate the debt or continue to make payments on the remaining balance.

    Crucial Takeaway: Due to the severe, long-term credit and financial consequences of shared liability, I always advise clients to think carefully through the decision of adding themselves to any loan as a co-borrower or co-signer.

    This issue has become particularly common with student loan lenders that require a parent to co-sign. When the student struggles with payments, the lender pursues the parent. The risk is significantly higher for the parent, who is often more financially established and has non-exempt assets that a lender can seize, putting the parent at risk of losing their savings or property.


    Professor Hernandez is an attorney specializing in consumer finance and debt relief. He is the published author of Consumer Bankruptcy Law (Routledge Publishing) and teaches law and finance courses in both English and Spanish for an international university.

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    Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.

    Initially updated on December 31, 2024.


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