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Co-signing loans: what happens if the original borrower dies?

Posted by Cheryl Costa  August 13, 2008 10:29 AM

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I am 28 years old and soon to be a third year law student. I have approximately $140,000 in student loans and a parent has co-signed on $75,000 of the debt so that I could qualify for lower interest rates and reduced origination fees.

I am worried about what would happen if some catastrophe should strike which would require my co-signer to take responsibility for the debt. Should I look into life insurance to cover the co-signed loans or should I try to re-pay the co-signed loans first? I was hoping to pay down those loans last because they have the lowest interest rates.

What a great question. I think it is fantastic that you are thinking that far in advance and trying to structure your finances to minimize any negative impact on your co-signers. The good news is that most student loans have a provision that states that the loan is discharged or cancelled in the event of the death of the original borrower.

This provision is not universal and can vary depending on the type of the loan, the guarantor and other terms of the note so you would need to check with your provider. However, the odds are very good that your parent would not be on the hook for repayment in the event of your death.

Similarly, most loans have a provision that cancels or discharges your loans in the event of your total and permanent disability. There are a few requirements that must be met and the first one is that the condition that caused the disability must not have existed when you applied for the loan. Also, you have to prove that your disability prevents you from working or earning any money and you have to prove that the condition is expected to continue indefinitely or result in death.

Check out the SallieMae website for more information on loan discharges due to death or disability.

It is important to note that so far, we have been talking about loans that the student has taken out. A different set of rules apply to PLUS loans, which are loans that parents take out. In the case of PLUS loans, if two parents are responsible for a PLUS loan and one of them dies, the survivor is required to pay back the loan.

Before we leave this topic, I do have to warn people about the dangers of co-signing a loan. Many co-signers are not aware that their credit score can be negatively impacted even if the original borrower is dutifully making all loan repayments. That is because the loan will show up as a liability on the co-signers credit report. If the co-signer wants to buy a home or a car or some other large purchase, they may be denied credit because their debt level is deemed to be too high. Anyone thinking of co-signing a loan for someone else has to be extremely cautious. Always remember that the reason someone needs a co-signer is that a professional lender has deemed the applicant too risky to lend to.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
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