It is never fun to think about student loans. It is even less fun to think about your death or the death of a loved one. This article will hit both subjects in explaining why student loan cosigners and borrowers should have life insurance policies.
I’ll also cover one shortcut that can eliminate the need for a policy.
The good news is that a little bit of planning can prevent a variety of student loan nightmares.
If the Borrower Dies: The Worse Case Scenario
The purpose of a student loan cosigner is to have a second person legally responsible for the student debt.
If the borrower doesn’t find a job or can’t make payments, the student loan bill becomes the cosigner’s responsibility.
When cosigners add their name to a loan, they often consider what they will do if the borrower falls behind. Cosigners usually have a close relationship with the borrower, and most feel confident that if a borrower struggles, it will be a temporary issue.
Unfortuantely, many cosigners don’t consider what happens if the borrower dies. In the eyes of some lenders, nothing changes. If the borrower is deceased, they cannot make payments, and repayment becomes the cosigner’s responsibility. President Joe Biden ran into this very issue when his son died.
This particular term varies from one lender to the next. When a lender holds the cosigner responsible for the debt, the consequences can be devastating.
In some cases, the cosigner becomes responsible for the monthly payments. In other cases, the full balance of the loan is due.
Important Note About Federal Loans: This particular issue does not apply to federal student loans. Federal loans do not have cosigners. Additionally, when the borrower dies, the remaining federal loan balance is forgiven.
If the Borrower Dies: The Second Worst Case Scenario
Suppose the borrower dies and the lender forgives the debt.
The loan contract may specify that the debt is forgiven if the borrower dies, or the lender may choose to cancel the debt. Both options are better than getting stuck with the bill.
Unfortunately, the cosigner may still have financial issues. The IRS may treat the forgiven debt as taxable income. Meaning if $100,000 gets forgiven, the cosigner is taxed as though they earned an extra $100k that year.
Recently, Congress passed temporary legislation to protect families from tax bills when student loan borrowers die. However, even with the new law, it is challenging to navigate the taxability of canceled debt.
Here again, family members can face massive tax bills if a loved one dies unexpectedly.
If the Cosigner Dies
The death of the primary borrower is not the only concern.
Some private student loans have provisions that make the entire student loan balance due in full if the cosigner dies. A study from the Consumer Financial Protection Bureau found that many private student loans had “Auto Default” provisions. An “Auto Default” provision may be triggered even if the borrower has been in repayment and not missed a single payment.
Life Insurance: Protection from the Unexpected
Most healthy young people don’t spend much time considering the possibility of their death.
Life insurance solves this potential problem for student loan borrowers and cosigners. For young and healthy borrowers, setting up a policy can be inexpensive and easy. If tragedy strikes, a life insurance policy protects the family left behind.
Who Should Pay for the Life Insurance Policy?
Ideally, there should be two policies—one to protect the borrower and one to protect the cosigner.
I’m of the opinion that the borrower should pay for both policies. Cosigners take on a tremendous amount of risk by signing for a student loan, and they gain nothing in return. A life insurance policy protects the cosigner. It is also an excellent way for borrowers to show gratitude for cosigning.
However, borrowers may not be in a position to afford a policy. They may choose not to get one. In that instance, it is the responsibility of the cosigner to protect their own interests and take out a policy. And yes, it is possible to take out a life insurance policy on someone else.
A Cheap and Safe Way to Skip the Life Insurance Option for Student Loan Cosigners
Most of the problems described in this article disappear if the cosigner is removed from the loan.
Many lenders offer cosigner release policies, but qualifying is difficult. Fortunately, there are several different ways to remove a cosigner from the loan. If the pursuit of a cosigner release is successful, borrowers and their cosigners are protected, and no life insurance is required.