Are You Responsible For Your Kids’ Bad Debts?

Did you read about the couple who are being forced to pay off their deceased daughter’s student loans?

Not only does this couple have to deal with the heart-breaking grief of losing their child, they are ruined financially as well. That’s because they have to use up their life savings to pay off her debts. How can this happen and how can you protect yourself?

More Background

Steve and Darnele Mason were good parents. They wanted to help their daughter Lisa as much as possible. So when she needed co-signers for her student loan, they were only too happy to help. But they failed to protect themselves when they did so.

Tragically Lisa died a few years later leaving behind 3 children and over $100,000 in unpaid debt. Because the Mason’s co-signed for the loan, they are being forced to take over for Lisa and make good on the debt.

It’s impossible not to feel for this poor family. Their loss is unimaginable. But if we want to learn from this experience we have to be honest and frank. The financial problem they face wasn’t caused by heartless capitalist bankers. They co-signed the loan of their own free will. That means they promised to pay the money back if their daughter couldn’t – for whatever reason.

Aren’t Loans Forgiven When The Borrower Dies?

Sometimes. Federal student loans, Perkins loans or Direct Loans or FFEL Program loans have death discharge provisions. But not every student loan does. Obviously, the loan that Lisa made did not have this clause. As a result, the lender has the legal right to go after the parents. This is cold but it’s true. And rather than complain about the fairness or unfairness of the situation, let’s spend a few minutes discussing a few tactics you can use to protect yourself from a similar outcome.

How can you make sure this doesn’t happen to you?

Odds are very low that you’re young adult children will predecease you. That means they probably will be around to pay their own debts and that’s great news all the way around. The bad news is that not all of our children will be able to keep with their student debt payments. If you co-sign those loans you are still vulnerable.

Fortunately there are three steps you can take to eliminate the risk of ever having to worry about paying off loans that aren’t yours:

1. Don’t Co-Sign Loans

The easiest way to avoid the problem the Mason’s is to never co-sign a loan for anyone else. Keep in mind that when you co-sign a loan, that loan belongs to you. You have to be prepared to accept that responsibility. If you don’t have the resources to fulfill that responsibility in the event that the primary party defaults, don’t take on this obligation. Instead, suggest to your loved one better alternatives:

• Get through college without taking on debt.
• Get private financing.
• Ask someone else to co-sign.

2. Life Insurance & Collateral

If, despite all the alternatives presented above, you do co-sign a loan, the very minimum you need to do to protect yourself is buy inexpensive temporary life insurance for the on the primary borrower. Needless to say, had the Mason’s done that they would only be dealing with one tragedy rather than two.

You can also protect yourself by having the borrower provide collateral like cars, boats and real estate. This is usually a non-starter when it comes to family but if your borrower is in a position to provide this safety net for you, take advantage of it.

3. Death Clause

I mentioned above that some loans are forgiven if the borrower passes away. Find out if the loan you are about to co-sign has that provision or not. If not, consider other alternatives even if the interest rate is higher. Think of that higher rate as a type of built-in life insurance.

When you co-sign a loan you take on huge responsibilities. Don’t take this step lightly. Try not to take this step at all. But if you have no choice, protect yourself by buying insurance on the borrower and/or getting as much collateral as possible.