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From Banking and Finance Law Daily, April 22, 2014

Co-signers can cause surprise defaults on your private student loans, says new CFPB report

By Stephanie K. Mann, J.D.

The Consumer Financial Protection Bureau has released a report on the complaints that the bureau has received relating to the private student loan industry’s practice of placing borrowers in default even when their loans are current and in good standing. The report, “Mid-year update on student loan complaints,” states that more than 2,300 private student loan complaints and more than 1,300 debt collection complaints related to student loans have been received between Oct. 1, 2013, and March 31, 2014.

Approximately 90 percent of private student loans in 2011 were co-signed. However, many private student loan contracts include an option for lenders to demand the full balance of a loan when a borrower’s co-signer has died or filed for bankruptcy. Many of the consumer complaints received by the CFPB indicate that industry participants are automatically placing loans in default, even when a borrower is paying as agreed.

“Students often rely on parents or grandparents to co-sign their private student loans to achieve the dream of higher education. When tragedy triggers an automatic default, responsible borrowers are thrown into financial distress with demands of immediate repayment,” said CFPB Director Richard Cordray. “Lenders should have clear and accessible processes in place to enable borrowers to release co-signers from loans. A borrower should not have to go through an obstacle course.”

Recommendations. The report notes that private student lenders and servicers may not always be acting in their own self-interest by accelerating balances and placing loans in default. Instead, the CFPB has recommended several alternatives worthy of further evaluation, including: assessing the borrower for co-signer release and maintaining the existing payment schedule, providing the borrower with the opportunity to identify a new co-signer, or providing time to refinance the loan.

Co-signer release. In a related blog post, the CFPB notes that the vast majority of private student loans today have a co-signer (typically a parent or a grandparent). Having a co-signer can often lead to a lower interest rate. However, the loan might also contain provisions that allow the student loan servicer to put the student in default—even if the student has been making payments on time—because a co-signer is also on the hook for the loan and, therefore, changes in the co-signer's behavior can impact the loan, causing it to default and making the entire balance due at once. The CFPB has received complaints that private student loan servicers are placing borrowers into default when their co-signer dies or files for bankruptcy.

The CFPB advises borrowers and co-signers to look into a "co-signer release," under which a co-signer may be released from a private student loan after a certain number of consecutive, timely payments, and a credit check to determine if the student is eligible to repay the loan. The bureau has provided sample letters for lenders and co-signers that can be sent to the student's loan servicer to determine steps that the lender needs to take to qualify for a co-signer release and when a lender is eligible for a co-signer release.

CBA statement. In response to the release of the report, Richard Hunt, president and CEO of the Consumer Bankers Association released a statement: “When tragic circumstances occur, CBA members work with their customers carefully and compassionately. For example, it is common practice for student loan lenders to release cosigners from loan obligations upon the death or permanent disability of a student borrower. We are not aware of lenders accelerating the payment of a loan in good standing upon the death or permanent disability of a cosigner as a typical practice and believe it to be a rare occurrence.”

Companies: Consumer Bankers Association

MainStory: TopStory CFPB Loans

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