Nothing is certain, they say, except death and taxes. And it used to be, repayment of federally guaranteed student loans was about as certain as things get. The reason: Probate laws.
Here’s how it works
When you die, all property attached to your name falls under the control of a bunch of attorneys at the courthouse. These attorneys then have the job of figuring out what you may owe to any creditors. Naturally, the probate process generates fees – sometimes tens of thousands of dollars in fees. And these attorneys are first in line. They also contact the IRS and state and local revenue officials to determine if you died owing the government any money. And they contact known creditors or advertise your death to see if you have anyone else you borrowed money from that needs to be paid back. The probate attorneys will not release money or property to your heirs until your debts are paid. Your loved ones get what’s left over.
Any loans that are federally guaranteed get taken right out of your estate before any money is released to heirs. If the probate attorneys have to sell some real estate or other assets to raise cash to pay off student loans, the IRS or other creditors, they’ll do so. Your family will get whatever is left over after the probate process.
For Sallie Mae debt incurred after 2009, though, there is a way out: The Smart Option Student Loan. Loans under this program are automatically forgiven if the borrower dies or becomes disabled before the balance is paid off. Naturally, if the borrower dies, he or she has other concerns. The loan is also forgiven in the event of total and permanent disability, as well. The disability forgiveness clause is tough to qualify for: To qualify for forgiveness your disability has to be both total and permanent. In practice, “permanent” means your disability can be expected to result in death, or can be expected to last for a contiguous period of not less than 60 months.
But the nice thing about this program is this: In the event of death or total disability, any cosigners are off the hook as well.
Sallie Mae can do this for very little cost, because they know that the death and disability rates (mortality and morbidity rates, in actuarial lingo) are very low for recent college graduates, and can be reliably predicted in advance.
Parent PLUS loans are also forgiven on death, even to the parent who obtained the loan for the student, if the student dies.
In most cases, if a creditor forgives a loan, the IRS counts the amount forgiven as income, and survivors or cosigners may get an income tax bill on the entire amount.
To claim the forgiveness, survivors or the representative of the estate should fill out Sallie Mae’s Death Discharge form, which notifies the U.S. Department of Education that the borrower is deceased. They’ll also have to send in a raised seal or otherwise certified copy of the death certificate to the loan servicing company (in the case of Direct Loans and FFEL Program loans), or to the school if the borrower had a Federal Perkins loan out.
Private loans, however – loans that are not federally guaranteed – will go through probate, unless there is a clause in the promissory note that releases the obligation at death.
For other federally guaranteed debts, however, you’re still liable for them – even if you die. Thanks to a legal and administrative process called probate, the government will get theirs, before your family gets to inherit a cent of your property.
Does My Spouse Have to Pay Off My Student Loans if I Die?
If you die owing a balance on your student loan, can the creditor go after your spouse? That depends on whether your state is a community property state or a common law state. In community property states, every spouse is potentially liable for the debts of the other. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. (In Alaska, married couples have an option to make their assets community property. This is ordinarily a bad idea if there is a lot of debt involved.
Usually, debts incurred during the marriage fall under community property laws, and your spouse may be liable for these debts in the event of your death. If you own property jointly with your spouse – or anyone else, for that matter – that property could potentially be seized by probate lawyers to satisfy a judgment. A lot depends on specifically how that property is titled. Consult with a lawyer to see how that will play out in your state.
Some community property states exempt certain kinds of education loans from this provision, however. Of course, if your only school debt is a Sallie Mae Smart Option Student Loan, described above, Sallie Mae writes off the debt whether you’re married or not. Both the primary debtor and the co-signer are off the hook.
Generally, federally-guaranteed student loans have come with a forgiveness-at-death provision, whether the student is married or not, and the spouse won’t have to worry.
In common law property states, your spouse generally will not automatically become liable for debts you take on by yourself, whether in or out of the marriage. So if the primary debtor passes away, assets that belong to the surviving spouse alone will not generally be subject to seizure, and the courts cannot go after him or her to garnish wages or take other steps to collect. Surviving spouses are more insulated from a deceased spouse’s debts in common law states than in community property states.