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When taking out a loan, you might think it’s safe to ask Mom and Dad to co-sign for you. You fully intend to pay the student loan back yourself after you graduate from school, right?
The problem with this idea is it could bite you in the . . . well, you know.
According to the Consumer Financial Protection Bureau, a federal watchdog group, there is a new twist in the student loan saga. If you take out a school loan from a bank or private lender with a cosigner’s signature and the cosigner dies before the loan is paid off, the lender can demand full, early repayment of the entire balance.
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But wait. It gets worse. If you don’t pay the balance in full, they can force the loan into default without ever sending a payment demand.
The CFPB didn’t say the loan companies are doing anything illegal. You are bound to the terms of a signed contract as long as the bank doesn’t hide anything from you. It’s up to the borrower to read the loan papers.
There is a potential for disaster for both signers. Students who borrow money are in debt up to their eyeballs before they even start to earn an income. Their ability to save for a house or retirement is severely cut down because of the huge payments that await them. And if something happens to the cosigner, the student could suffer the double whammy—a mountain of grief and a mountain of debt due.
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The parent (or cosigner) is essentially signing up to pay for the child’s schooling. The banks have done their research. They know that the child statistically won’t be able to pay, so they get Mom or Dad on the hook for the money. The parents will likely remain as cosigners for the duration of the loan, because the students won’t have enough income to refinance. That means the parents are now legally responsible for a big monthly payment when they should be saving for retirement.
Some people might say that as long as you get federally insured student loans, this won’t happen. That’s not our point. What we are saying is when you borrow for school—much less co-signing on a loan for it—everyone is risking a lot (in America, the private-loan market itself is around $150 billion).
There is no good reason to open yourself up to this risk in your life. Even if the chance that something goes wrong is small, the potential for disaster is big. It’s like dying with no life insurance and leaving your debt-ridden family members to fend for themselves. If that small chance hits, it hits hard and doesn’t go away. Stay away from borrowing for school, and that hard hit never happens.
There are much better ways to teach your kids about responsibility with money than co-signing on a loan. Check out Dave and Rachel’s new book Smart Money Smart Kids to learn how to raise money-smart kids and change your family tree!