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Co-authored by ekraus

On April 22, 2014, the Consumer Financial Protection Bureau (CFPB) issued guidance called “Consumer Advisory: Co-Signors can cause surprise default on your private student loans.”  Most private student loans contain a provision that if a co-signor dies or declares bankruptcy, a default is triggered and the student borrower must pay all amounts due immediately.  This event of default occurs even if the debtor has paid all payments in a timely fashion and the loan is current.  Further, as long as the co-signor is on the loan, the co-signor’s credit is affected.

Most private student loans require a co-signor, and typically a parent or a grandparent is wiling to act as the co-signor.  The likelihood of a parent or grandparent dying while the loan is still in service is greater now that student loans are lasting longer.

Typically, once a borrower is out of school and in repayment status, a “co-signor release” may be obtained.  There are different requirements depending on student loan services, such as credit check and a history of timely payments.   Often, the student loan servicer will not provide details about when the co-signor may be released.  Consequently, the borrower or co-signor needs to inquire.  Attached to the advisory above are templates to assist in following up with the debt servicer.

As part of an overall estate planning, parents and grandparents that have co-signed on a child’s private student loan should make sure the child follows up as soon as the child is in loan repayment status to determine what requirements are necessary for a co-signor release.  Even if a parent or grandparent leaves enough assets to the child to repay their loans, probate can take at minimum six months from the date of death.  If the loan goes into default on the date of death and repayment is required immediately, the child could be in a position to be unable to pay for at least six months, creating a significant strain on the child.  By securing a co-signor release before death, the child can continue to make payments without the risk of an event of default.

If a co-signor finds they are in a distressed position, the co-signor should notify the borrower as soon as possible so a co-signor can be obtained.  Obtaining the co-signor release prior to filing for bankruptcy will protect the borrower from an unnecessary default.