Jerry Jones CPA
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Co-signing a Student Loan is Serious Business, with Consequences

student loan blindsided parentDear Pete,

While establishing a home equity line, my wife and I discovered that my son had actually defaulted on two college loans that we were the cosigners on. We hadn't seen any correspondence from the bank in over a year, so we assumed he was current. Long story short, we couldn't close till these notes were paid. I called the lender and negotiated a payoff. We paid it, problem solved, so I thought. We just got two 1099C IRS filings from the lender. The lender NEVER mentioned to me during the negotiations that there would be a tax consequence. I assumed it was just a give and take negotiated settlement.

Is there anything I can do?

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Blindsided Parent

Dear parent: I wish your email were the first time I heard a story like this. It's not. I could host a show called Cosign Nightmares and never run out of material. What makes the stories so dramatic is the idea that a family can bond together to triumph over the restrictive nature of banks, with the possibility of thumbing a nose at the bank while screaming “we told you so.”

I know what you’re thinking. Your goal wasn’t to thumb your nose at a bank. Your goal was to help your son get the loans he needed for his education.

Private student loans, unlike federal loans, are underwritten. Federal loans disregard credit history, income and the ability to pay back the loans. What do you get when a loan isn't underwritten? Chaos. The assumption that everyone can and will pay back a loan is absurd, yet the money flows like cheap wine. The government keeps federal loan rates relatively low. Private student loans are very different. When a private lender extends a student loan package, underwriting is front and center. Underwriting not only affects whether or not the loan package is extended, but the interest rate as well.

When your son applied for his private student loan, the lender looked at his creditworthiness and said nope. That, or they said yes and offered him a very high interest rate. So far, so good. Private lenders have seen millions of situations exactly like your son’s. They’re willing to dance with a borrower like him, but they’re going to dance by their rules. That’s how you got involved. Unfortunately, parents tend to frame the cosigning process much differently. Parents like to view cosigning as an annoying formality.

Whether you reluctantly cosigned the loan documents or not, the loan was made on the basis of your ability to repay it, not your son’s ability to repay it. A cosigner’s job is not done at the time the loan documents are signed. You think you’re walking beside the borrower as they climb the debt mountain. You’re wrong. You’re carrying them up the mountain. If they fall off your back, too bad. You have to keep going. In your situation, you sent your son up the mountain, and you went to grab a cup of coffee.

college student student laon cpaIn an effort to teach your son a valuable lesson, you learned a more valuable one.

Every document you sign matters. That was supposed to be the lesson for your son, but it ended up being your lesson, too. When you cosigned the loan, you told the bank you were willing to keep an eye on the inexperienced borrower. You didn’t. Panic set in, especially when you applied for your home equity line. I can imagine the anxiety that comes with discovering you're being denied the ability to borrow money because other borrowed money has been ignored.

The 1099C you received is standard in most debt settlement cases. Since the lender forgave your debt, it’s considered taxable income for you. In essence, you were given an economic advantage when your debt was forgiven, you must now pay tax on that advantage. That’s one of the dirty little secrets to debt settlement. You no longer owe the lender money, but you will almost certainly owe Uncle Sam.

Your question was, “Is there anything I can do?” Yes. Start taking your financial decisions seriously. The actual consequences of all major financial decisions must be considered, not dismissed because they’re in the small print.

You chose to be blindsided.

If I’m you, I’d comb through every major financial decision I’ve made over the last 15 years to make sure there isn’t a pattern of blissful ignorance. Is your home at risk? Is your retirement? They might be, if you used the same cloudy lens to make those decisions, too. It would be a mistake to assume you took your “bigger” financial decisions more seriously.

As my grandpa used to say, “If you don’t take care of your bike, you’re not going to take care of your car.”

Peter Dunn is an author, speaker and radio host. Have a question about money for Pete the Planner? Email him at AskPete@petetheplanner.com

 

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