This series on our blog, Student Loan Questions, answers questions many students have about student loans. This week we answer the question: What if I used a co-signer?

Used a co-signer for your student loan? You may be headed for serious trouble…

Student Loan Questions

While a parent or grandparent may be somewhat reluctant to co-sign for their offspring’s first car, they usually will not hesitate to help with a school loan.  The thought of their child or grandchild desiring a college degree will usually cause the ink pen to come out and signature to go onto the dotted line to help the student with school costs.

One of the most common student loan questions is what happens if that co-signer becomes disabled or dies or files for bankruptcy?  According to the CFPB (Consumer Financial Protection Bureau) this scenario is becoming a real problem.  Evidently most of these contracts call for an immediate payoff (by the student) if something happens to the co-signer even if the payments have been made on a timely basis.

The Legal Basis

Long term contracts made with short term longevity-concerns is the basis for the clause in these contracts.  Unlike a mortgage, the student loan is usually not tied to real property that can be encumbered; the co-signer’s good credit standing is the collateral. If that is lost through death or insolvency, the note can be called.  The student has to pay the school loan off.

While this acceleration option may have a legitimate business purpose, it seems that private student lenders and servicers may not always be acting in their own self-interest by accelerating balances and placing loans in default since it is possible that the note isn’t called.  However it is very difficult to alter the contract clause.

In layman’s terms? This can create a real nightmare for the student who typically is not in a position to pay a large dinner-date tab, let alone a student school loan. In fact, anxiety from debt is one of the main reasons for suicide among college students. So, what should be done if you are in a contract like this?

Your Exit Strategy

Be proactive and have an “exit strategy”.  You can arrange your affairs so that in the event you are faced with having to pay off your school loan, money is available to you.  How?  Try these strategies:

  1. Ask your co-signer if you can take out a life/disability insurance policy on them for the amount that would cover the loan in the event it is called. There are products available called “decreasing term” that are very inexpensive.  These policies reduce in the pay-out amount as the school loan balance decreases and can be drawn up so they “term” or conclude when the school loan has finally matured.  If you explain to your parent/grandparent the reason for the policy, it will be evident to them the soundness of the strategy and probably insist on paying for the policy themselves.  Either way, it is not too costly and in the event of a tragedy, the school loan can be paid with the insurance money.
  2. The same concept can be used for a disability as well.  Disability insurance is very affordable and the money from the policy could be used to pay off the school loan in the event it is called due to the disability.
  3. Strategies number one and two will not help if the co-signer files for bankruptcy however.  To protect yourself in this instance, you could apply for a student credit card.  There are cards designed specifically for students.  Having a student credit card can certainly be a problem for some people but if used properly, can be a huge asset.  First of all, proper use of a credit card will build your credit…and not having credit is the very reason you needed a co-signer to begin with.  Second, if used properly, the credit limit can be increased until it finally reaches the amount needed to pay off a student loan if necessary. Third, once graduated and in the workplace, you will not be financially handicapped in this credit-world we live in because you will have built a nice credit profile.

In our next blog we’ll discuss the proper use of credit cards and how to make them work for you.