By Dr. James M. Dahle, WCI Founder
A surprising number of people don't refinance their federal direct student loans because they are worried they will lose the death and disability protections available in that system. So, let's talk about it.
Are Student Loans Forgiven If You Die?
With your direct federal loans: if you die, your loans are completely forgiven as soon as a death certificate is sent.
What Disabilities Qualify for Student Loan Forgiveness?
If you are permanently and totally disabled per the government's definition, then your direct federal student loans are forgiven. Curious what it takes to be permanently and totally disabled? Well, you can meet VA guidelines. Or you can meet Social Security guidelines. Or you can get a physician to certify that . . .
You are unable to engage in any substantial gainful activity due to a physical or mental impairment that
- leaves you permanently and totally disabled,
- has lasted for a continuous period of at least 60 months, or
- can be expected to last for a continuous period of at least 60 months.
Substantial gainful activity is a level of work performed for pay or profit that involves doing significant physical or mental activities, or a combination of both.
Prior to 2018, this forgiveness was TAXABLE, so your estate would owe a tax bill there. Essentially, the government would send your estate a 1099. However, the Tax Cuts and Jobs Act changed the law such that starting in 2018, the forgiveness of federal student loans in the case of death or permanent disability is now tax-free. In fact, all federal student loan discharges until the end of 2025 are tax-free thanks to the American Rescue Plan.
What Is This Death/Disability Forgiveness Benefit Worth?
That's a nice feature of federal student loans, but how much is the benefit really worth?
Well, if you're planning on paying off your student loans over a period of five years, it's worth precisely what it would cost you to buy enough life insurance to cover that expense for a period of five years. If you're a healthy 35-year-old, a five-year level term policy for a $200,000 benefit costs as little as $150 per year. So, over the course of five years, that costs $750. Technically, it isn't even worth that much as the amount to be forgiven goes down each year. So, maybe it's worth $500.
What about disability? Well, a good individual disability policy typically costs 2%-6% of the amount of income covered. But this isn't a good disability policy. In fact, you have to be disabled for five years before it even kicks in, and then it has a very strict definition of disability. So let's say it's worth 1% of the amount of income covered. How much income does it take to pay off $200,000 in 6% student loans over 30 years from age 35 to age 65? That's $14,530 per year. One percent of that is $145 a year, or $725 for five years. Again, it's worth less and less as your student loans are paid off, and it seems generous to assign it a value of $500.
So $500 worth of life insurance and $500 worth of disability insurance for $1,000 total. That's what this death and disability benefit is worth. Note that under current law, private loan forgiveness is taxable and federal loan forgiveness is not, so be sure to adjust the value upward somewhat for that. So maybe we're talking about $700 of each type of insurance and $1,400 total.
What Is the Death/Disability Forgiveness Benefit Costing You?
Now, what is this benefit costing you? Let's run the numbers. If you have $200,000 in student loans at 6% and you could refinance those loans to 4%, that's 2% a year in extra interest you are paying. If you pay off that student loan over five years, not refinancing will cost you an extra . . . $31,933-$20,998= $10,935.
In essence, not refinancing costs you at least 10 times as much as the forgiveness benefit is worth. This is obviously a terrible financial decision for healthy people.
What About Co-Signers?
Sometimes you may not be able to qualify to refinance your student loans without a co-signer such as a spouse or parent. The benefit of using one is a lower interest rate. The downside is that the co-signer may still be responsible for the loan if you die. Be sure to weigh in the cost of a little extra life and disability insurance if you use a co-signer.
Private Student Loan Refinancing Companies Offer Similar Death/Disability Protections
Most of these student loan refinancing companies actually provide a similar benefit to the federal government! I asked all of my student loan refinancing partners to participate in this exercise and have listed the responses received below.
As you can see, most offer forgiveness for death, and some offer forgiveness for disability. Note that they do send you (or your estate) a 1099 because that forgiveness is taxable. The American Rescue Plan does not apply to private loans.
Note that links on this page are affiliate links, so if you refinance your loans after going through them, WCI gets paid. That's OK, you get paid too. Not only do you get a lower interest rate, but you usually get several hundred dollars in cash back that you wouldn't get if you went directly to the company and, for a limited time, our flagship online course, Fire Your Financial Advisor.
Laurel Road told me this:
Laurel Road will forgive all or part of the customer's student loan in the event of death or documented permanent disability. If the borrower dies or becomes disabled, the cosigner is released from the loan. If the co-signer dies or become disabled, they are released from the loan.
I asked “Who decides whether all or part is forgiven? And if part, what part? How is that worded on the promissory note?” Here was the response:
Determination of loan forgiveness is made by senior management committee and is dependent on the borrower’s situation. We generally do provide a 1099 for the amount forgiven. Here is how it is worded on the promissory note:
The lender will forgive (waive or cancel) (a) all of the amounts owed under my loan if the Borrower signing below dies, and (b) some or all of the amounts owed under my loan if the Borrower signing below demonstrates to the lender's reasonable satisfaction a significant unanticipated permanent reduction in Borrower's total income due to Borrower's permanent disability. I understand that the lender may condition its agreement to forgive (waive or cancel) some or all of the amounts owed under my loan on receipt of documentation (including updating documentation if applicable) evidencing the Borrower's death or (if applicable) the nature, expected duration and amount of the unanticipated reduction in Borrower's total income due to Borrower's permanent disability. I also understand that I should consult a tax or financial advisor about possible tax consequences of any forgiveness (waiver or cancellation) of some or all amounts owed under my loan.
Brazos says this information is listed in its FAQs, which read:
What happens to the loan if I or my cosigner dies?
We do not accelerate the debt, or declare the loan in default, upon death of any party and we do not pursue the estate of any deceased individual.
If the primary borrower on the loan dies, and there is no cosigner, the loan is forgiven. If the primary borrower on the loan dies, and there is a cosigner, the primary borrower on the loan is removed and the cosigner is responsible for repayment of the loan over the remainder of the repayment term. If the cosigner dies, the cosigner is removed from the loan, and the borrower continues to be responsible for repayment on the loan over the remainder of the repayment term.
There is no disability forgiveness with Brazos, and it will send the estate a 1099 in the event of death, just like the government used to do.
In the unfortunate event of death or total and permanent disability, Earnest will discharge all student loans. More information on what protections we offer can be found here.
Earnest notes that it does send a 1099.
First Republic says:
Death and disability do not extinguish the borrower from the loan and the borrower’s estate would remain liable for the outstanding loan obligation. This is what you would read in our loan documents. Let me know if you have any further questions.
Better buy a little extra insurance if you refinance with First Republic. Remember also that First Republic loans are not student loans, so you can't refinance them again with another student loan company.
The company said:
Parent Refi and Parent Inschool Loans do not qualify for the following options. Additional eligibility criteria and requirements may apply. To determine if you qualify, please call us at 877.292.7470.
- Death Discharge — In the event of a borrower’s death, and if SoFi receives acceptable documentation thereof, such as a certified copy of the death certificate.
- Disability Discharge — If you become totally and permanently disabled (“TPD”) as defined below. In order to establish total and permanent disability, you must demonstrate to SoFi’s satisfaction that you are unable to engage in any substantial gainful activity due to a physical or mental impairment that can either: (i) be expected to result in death; or (ii) has lasted for a continuous period of not less than 60 months; or (iii) can be expected to last for a continuous period of not less than 60 months.
They do send a 1099, as this is taxable income.
We had a reader who ended up becoming disabled with SoFI loans. We discovered that if you have other income that keeps you above poverty line (such as disability insurance) that your loans would not be forgiven by SoFi. Our contact said:
After doing some digging on my end, I was able to determine that in addition to meeting the TPD standard already specified, a borrower cannot be receiving supplemental income in excess of the poverty guidelines for a given area.
Here's what the top of their application says:
That last line is the most important in the whole eight page application.
The company said:
While there is there is no specific language around debt forgiveness upon death/disability in the loan agreements via LendKey, there are two things to keep in mind:
1. Our lenders are prohibited from declaring or accelerating private student loan debt on the sole basis of the death or bankruptcy of a cosigner on the loan; and
2. Our lenders must release the cosigner on a student loan upon the death of the student borrower.
This applies to all private education loans, as well as refi loans that include the refinancing of a federal private education loan. Both of these rules are based on changes in the law that went into effect last year, so they are not unique to LendKey lenders.
It is certainly not a frequent occurrence given the relatively young age of the borrower demographic; but if it happens, we immediately notify the lender and the lender determines how it wants to handle the situation if it does not fall into one of the two scenarios above. These lenders are often not-for-profit credit unions and community banks who do everything they can to support their members and customers, but there is no guarantee of forgiveness in death or disability.
The bottom line with LendKey is that you could possibly get forgiveness here, but you'd probably better buy some extra life/disability insurance.
The CEO of Splash told me:
Since Splash works with multiple lenders (banks and credit unions), it varies on how this policy is applied. Some forgive in the case of death and some do not. Without question, the best borrower benefit is to have the loan canceled in the event of death or total and permanent disability but some of our lenders have instead opted for lower interest rates instead (forgiveness can cause lenders to factor extra losses in for everyone causing higher rates).
What is important is borrowers can view the specific policy for every lender (Splash & others on WCI) in the credit agreement which is the document that the borrower signs and contains all the legal terms and rights.
Here is a snippet from the credit agreement for one of our lenders that does not forgive a loan for death or disability. This language is likely exactly the same as other lenders who do not forgive.
Payment Due Notwithstanding Death or Disability. If I die, the terms of this agreement will be binding on my estate, which will be liable for any unpaid indebtedness. I also understand that if I become totally and permanently disabled, my unpaid indebtedness on this loan will not be canceled.
I asked what percentage of the lenders that Splash uses did not offer forgiveness:
Right now, the majority of loans are with lenders who do not forgive (I’d estimate 80% over the last year) but we are constantly working to both improve borrower benefits and maintain low interest rates.
Read the fine print and buy a little extra insurance if needed.
CommonBond keeps it simple:
In the case of the borrower's death or permanent disability, the loan is forgiven, even if they have a cosigner.
Note that this is better than most companies which will still keep the cosigner on the hook. CommonBond will send a 1099.
I didn't hear back from my contact at ELFI, but its general email staff replied to me with this:
At this time, each loan impacted by a borrower’s death or permanent disability is individually reviewed by our Credit Manager and legal counsel. Should this procedure change, borrowers will be notified.
Better buy the extra insurance, but you might as well try to get it forgiven. Maybe it'll work.
I did not hear back from Credible, but like LendKey and Splash, it uses many different lenders. So I suspect this issue varies by lender. Read the fine print and buy insurance as necessary.
Reset Refinance Loan from Iowa Student Loan, reports in its Q&A section on its site:
In the unfortunate event of a borrower’s death or qualifying total and permanent disability, Iowa Student Loan will forgive the loan and not require cosigners or the borrower’s estate to satisfy the loan obligation. A tax professional or the IRS can provide additional information about possible tax consequences of loan forgiveness. In the event of a cosigner's death or qualifying total and permanent disability, you will not be required to find a new cosigner for an existing loan. In addition, if a cosigner suffers a qualifying total and permanent disability, Iowa Student Loan will release the cosigner from his or her obligation.
Some Final Advice
As you can see, the death/disability protections available through the Federal Direct Loan program should NOT keep you from refinancing your student loans when it is otherwise advisable. In fact, if you're not getting a REPAYE subsidy and you're not going for PSLF or another forgiveness program, chances are you should have already refinanced, at least once the federal student loan holiday is over.
Student loans and the many programs and options are difficult to navigate. If you need help, check out StudentLoanAdvice.com, a WCI company.
What do you think? Did you make the mistake of staying in the direct loan program when you should have refinanced because you wanted protections like these? Are you surprised how little these benefits are really worth? Have you refinanced? Who did you use and why? Comment below!
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