Bankruptcy expert Leon Bayer answers real-life questions.
I co-signed a student loan for my adult sister. My sister defaulted, the loan is in collection, and we now owe $80,000. My sister has never held any job for long, and is on disability. I make about $45,000 a year. The debt collector has agreed to settle for $60,000 cash. I could pay that by liquidating my retirement plan, which I don’t want to do (my wife says she’ll divorce me if I do that). The collector also offered to rehabilitate the loan if I pay $4,000 up front and then make monthly payments of $320.
I can’t afford to make payments; my wife and I barely scrape by as it is. But I have about $300,000 equity in my home. Can I protect my house by signing it over to my wife and filing for divorce? We don’t really want a divorce, but I am at my wits end. Also, since I was only the co-signor, can the collector legally make me pay? Please give me any advice that might work.
I’m sorry you are in this mess. Let me take it step by step.
Are You Legally on the Hook for a Cosigned Loan?
Cosigning a loan is always serious business. People often misunderstand the consequences. When you cosign, it means you owe the money. If the other person does not pay as agreed, then you have to pay it for them. It can be legally enforced against you.
When somebody needs a co-signor, it is because the lender has determined that the person is not financially reliable and is at risk of defaulting. In your case, the lender looked at your financials and liked what it saw. You are a solid, responsible guy. If you had been in the same boat as your sister, the lender would not have made the loan.
Can You Discharge the Student Loan in Bankruptcy?
A bankruptcy won’t help because you will not be entitled to discharge the student loan. To discharge a student loan you must prove that to pay the loan would cause you undue hardship, which you won’t be able to prove in your situation. (To learn more about the undue hardship standard, see Nolo’s Student Loans in Bankruptcy topic page.)
Should You Transfer Your Home or Use Retirement Funds?
Transferring the house and filing for divorce is no solution. The lender may sue to set aside the house transfer because it was a fraudulent transfer, and then it could force it to be sold to pay off the debt. Draining your retirement money to pay the debt leaves you without a nest egg for the future.
Claims Against the School and Lender
Sometimes borrowers have a case against the school and the lender, especially if the school was a vocational school. And if certain circumstances apply, your sister might be able to get her loans cancelled altogether. Here are some questions that may apply. Did the school know your sister was unemployable and would remain unemployable after graduation? Perhaps it can be shown that the school made false representations to induce her to attend and for you to co-sign? Perhaps it knew the education could not benefit her in any way? Did the school go out of business before she finished? (To learn more, see Nolo’s topic area on Student Loan Cancellation.)
I suggest that you and your sister together go and see a lawyer who handles student loan cases. That is the best way to find out if you have any defense or can cancel the loan. Your question does not mention such facts, so I will continue under the assumption that no legal defenses are available.
Government Repayment Plans
If your sister has federal loans or federally guaranteed loans, you might want to check out some of the federal repayment plans. (To learn more about these plans, see Nolo’s article Income Contingent and Income Based Repayment Plans.) You’d first need to get the loan out of default (see Nolo’s article Student Loan Rehabilitation to Get Out of Default).
(For more on dealing with student loans, see Nolo’s Student Loan Debt topic area.)
But in your situation, it’s likely that the repayment terms under these plans will result in a higher payment than what your lender is currently offering you.
Taking the Lender’s “Deal”
Assuming you don’t have any claims against the school and cannot cancel the loan, here is my advice: Pay the $4,000 that is needed to rehabilitate the loan. Take it from your retirement plan if necessary. It is a much better option than cashing in your entire plan and winding up divorced. You say you can’t afford the $320 monthly payment. But a monthly payment of that amount is a fantastic deal for you. It allows you to keep an $80,000 debt under control. Find a way to make that payment. If necessary, a part-time job working a few hours per week is all you need. That is not as painful as a divorce would be. Also, the interest you pay on the loan might be tax deductible.
Here is what I want you to take from this. Save your marriage. Save your home. And save your retirement plan. The lender is being very generous to you under the circumstances. Take the offer.
Leon Bayer is a Los Angeles bankruptcy attorney. He is a partner at Bayer, Wishman & Leotta, a California law firm specializing in bankruptcy. The opinions and advice in this blog post are from Mr. Bayer alone, and should not be attributed to Nolo. By answering a question on this blog, Mr. Bayer does not become your lawyer.