One of the biggest financial challenges facing Americans today is the rise in student loan debt. There's more than $1.5 trillion in student loans outstanding, with an estimated 45 million borrowers owing money on this particular type of personal loan. Moreover, the crisis doesn't just affect young people, as the growing need for workers to return to school for training has led to a greater number of older borrowers taking out student loans as well.
As borrowing for education has become more prevalent among all age groups, one question that's coming up more and more often is what happens if you don't get your student loans paid off before you die. The answer depends on what kind of loan you have, and unfortunately, some people make decisions that have dramatic impacts on their loved ones after their death.
Federal vs. private student loans
In determining what happens to your student loans after your death, the key question is what type of loan you have. If you have a federal student loan, then the federal government will discharge any remaining debt upon your death. That means your balance will get zeroed out, and your loved ones won't have to repay the student loan after you die. That's true regardless of whether the loan is a subsidized Stafford loan, an unsubsidized federal loan, or a direct consolidation loan through the federal government.
The federal discharge of student loan debt at death can be especially useful for loans that parents take out to help pay their portion of their children's educational expenses. Parent PLUS loans are discharged in full not only if the student dies, but also if the borrowing parent dies. However, if both parents take out the loan jointly, and one passes away, the debt is not discharged, and the surviving parent becomes solely responsible for covering the payments.
By contrast, private student loans have no automatic provision for getting discharged if the borrower dies. Instead, it's up to the lender to decide how to handle the situation, and while some lenders follow the federal practice of forgiving student loan debt on death, others will try to collect from the borrower's estate if it has assets with which to repay the loan.
What happens to cosigners
In some cases, what happens to your student loans at death depends on whether you needed a cosigner in order to get the loan in the first place. With most federal loans, cosigners aren't even required, so the question is moot. Just about the only federal loan that can involve a cosigner is a direct PLUS loan, and even in that case, the federal government discharges the loan even if there's a cosigner on the account.
With private loans, the private lender again can decide how to handle the cosigner situation. From a purely contractual point of view, a cosigner is jointly responsible for repaying the debt for the original borrower, even in the event of the borrower's death. Absent language to the contrary in the loan document, the cosigner will still be on the hook for repaying the loan if the original borrower dies. However, some private lenders acknowledge the difficulties involved in handling student loans this way and choose instead to automatically discharge the cosigner's obligation after the original borrower's death.
Marriage and student loan debt
Often, even if a private lender chooses not to discharge student loan debt after the borrower's death, it's a moot point because the borrower's estate doesn't have any assets to repay it. However, if the borrower is married, state law sometimes requires the borrower's surviving spouse to repay the debt if it isn't discharged.
Most states don't allow lenders to go after a borrower's spouse if the spouse's name wasn't on the original loan. However, in community property states -- which include California, Washington, Idaho, Nevada, Arizona, New Mexico, Texas, Louisiana, and Wisconsin -- a surviving spouse can be responsible if the deceased spouse took out the loan during the marriage.
The biggest trap for the unwary
Because of the difference in treatment between federal and private loans, one of the biggest traps that a borrower can fall into is unwittingly exchanging a federal loan with favorable provisions for a private loan with unfavorable ones. The most common situation in which that happens involves student loan consolidation.
As mentioned above, there are ways to consolidate federal student loans in a manner that preserves their federal status. With a direct consolidation loan through the government's program, the favorable provisions of your federal loans with respect to loan forgiveness at death don't get taken away.
However, if you consolidate all of your loans -- both federal and private -- with a private lender, then you'll typically lose the beneficial provisions that the federal loans provide. That can have consequences beyond the loan's treatment at death, including loan forgiveness provisions for public service and other qualifying work. But it can also mean that student loan debt that would've disappeared after your death if you'd left your federal loans alone could turn into nondischargeable debt that your estate will have to repay.
Pay attention to student loan terms
If you want to avoid sticking your loved ones with a potential student loan bill after you die, it's smart to do the following:
- Get federal loans whenever possible.
- With private loans, borrow from private lenders that include terms to discharge loan debt upon your death.
- Avoid consolidating a favorable federal loan with a private lender outside of the federal government's direct consolidation loan program.
The lesson here is that with private student loans, it's especially important to look closely at the loan's terms to see whether it will be discharged at death. Otherwise, you could leave your loved ones to deal with the financial consequences of your outstanding debt -- and that's not a legacy anyone wants to leave to their family.