Agency Questions ‘Auto Default’ Practices of Some Private Lenders

April 22, 2014

Some borrowers with private student loans are being cast into default when their co-signer dies or goes bankrupt, warns a new report by the Consumer Financial Protection Bureau.

According to the bureau, some lenders demand immediate payment in full upon the death or bankruptcy of a co-signer, even when the borrower is current on the loan. Borrowers who don’t—or can’t—comply are put into default.

In other cases, lenders don’t even give borrowers the opportunity to repay the debt, putting them automatically into default.

Meanwhile, borrowers seeking to release living co-signers from their loans are forced to "jump through hoops" to do so, Rohit Chopra, the bureau’s student-loan ombudsman, told reporters in a call on Monday afternoon.

Mr. Chopra said the bureau cannot quantify how many borrowers are facing such challenges and hasn’t calculated how many complaints it has received from affected borrowers. But the complaints cover a wide range of lenders, he said, and appear to be on the rise.

The agency is concerned that the problem could worsen as current co-signers age and repayment terms stretch, he said, and wants to "alert the marketplace to where there are issues before they grow further."

‘Rigid and Opaque’

Since the 2007-8 credit crisis, many lenders have been unwilling to issue private loans to students without a co-signer. In 2011, 90 percent of private student loans were co-signed, up from 67 percent in 2008. Often, the co-signer is a well-meaning parent or grandparent who wants to make college possible for the borrower.

Most private-loan contracts allow borrowers to release a co-signer, typically after the borrower makes a certain number of consecutive, on-time payments and undergoes a credit check. But the bureau found that borrowers often face "bureaucratic barriers" when they attempt to do so. In some cases, the standards for releasing a co-signer are "rigid and opaque"; in others, required forms are not available online.

The report argues that such practices may not be in the best interest of either borrowers or lenders, who may receive less interest and principal over the life of the now-defaulted loan. It recommends that lenders and servicers make their co-signer-release policies more transparent and give borrowers a chance to find a new co-signer or prove their own ability to repay the debt in the event of a co-signer’s death or bankruptcy.

The report also suggests that lenders honor existing payment schedules for a set period of time after such events to give borrowers time to apply for a new loan or to refinance with a different lender.

The bureau has been collecting complaints about private lenders since March 2012, and it issues biannual reports analyzing those complaints. The latest report looks at complaints received from October 2013 to March 2014. The total number of complaints received during that period rose by almost 40 percent, compared with the same period a year earlier, the report says. Complaints against Sallie Mae, the nation’s largest lender, increased by more than 50 percent, from 659 to 995.