By Ryan W. Brooke
There are many instances where someone might offer to co-sign a loan. A parent may be helping a child with a loan for a vehicle or home, perhaps because the child lacks the credit history to secure a loan on their own. Someone might co-sign a home or vehicle loan for a friend who has poor credit history. In these instances, there is an actual item being considered that could be collected in the event of a death. But what about student loans? How “on the hook” are co-signers in the event of a death?
Understanding Your Loan
Federal Loans: There are many federal loans available that aren’t reliant on a borrower’s credit history. Students may not even need a co-signer for these types of loans. However, there are special types of federal loans that do require co-signers. The good news is, in the event of death, almost all federal loan obligations are discharged by the government. The obligation to the co-signer would be to show proof of death for the loan to be discharged.
Private Loans: Private loans tend to have stricter requirements for approval, and a co-signer may be on the hook for repaying the loan no matter the reason, including death. Before entering into these agreements, it is important for both parties to understand the obligation and the fine print of their agreement. Another point to consider is that if either party dies, it could automatically trigger the loan to be paid in full immediately. Borrowers and co-signers should understand this obligation and have a plan for repayment if that were to happen.
Co-signers usually have the best intentions for entering into a legal agreement, but may not always understand the impact it could have on their own financial health if the borrower were to pass away, or even if they were to default on a loan for any reason.
How can you protect yourself as a co-signer?
1. Consider the options – If you’re considering helping someone by co-signing a loan, ask if they have maxed out the amount of loans they can take. If they have not, consider talking with them about maxing out the loans they can take on their own before you come into the picture. Many parents want to be generous, but this option can make children understand the responsibility and have “skin in the game” when it comes to repayment.
2. Consider loan alternatives – If your child has maxed out their student loan options and you’re ready to step in, think about how you can protect your financial health while still offering help. Do you need to co-sign a loan or are there other options? You may consider gifting them some or all of the amount needed and letting them handle their own financial affairs, but there’s no legal responsibility for them in terms of a gift. Another option is to consider a written loan between you and the child. If they were to default on their loan, you have the potential to write it off as bad debt.
3. Consider loan institutions – If you determine that co-signing a loan is the best option, consider which lending option is the best for your situation, including a Parent Plus student loan. This option may have better terms than seeking a private loan from a bank or other institution. It may also offer loan discharge in the event of the borrower’s death.
4. Consider insuring your decision – It may make sense to take out a small life insurance policy, perhaps equal to the debt, in order to protect the borrower and co-signer. If both co-signers can’t support the debt, this could be an option in case one party were to pass away. While it may not make sense for a student loan, it could be beneficial in cases of other loans.
Some parents are ok taking a step back or working more years to help out their children and some parents are in a financial situation where they could take on the entire burden of their child’s education expenses if needed, or any other loan burden. However, no matter a parent’s financial situation, there could be drawbacks to their own financial security by co-signing a loan. If you’re considering co-signing a loan, first ask yourself, is this worth compromising my financial security?
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Published for the blog on March 29, 2020 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.