This past March, the Consumer Financial Protection Bureau warned banks that they were at risk for breaking the law by placing borrowers who were current on their student loan repayments in default when the cosigner on the loan dies or declares bankruptcy.
Private student loan lenders often require cosigners to make the loan debt more appealing for securitization. Having a cosigner take on the legal responsibility of the loan can lead to a lower interest rate because the cosigner is required to repay the loan if the borrower does not. The same problem is probably prevalent for those who took out low interest consolidation loans with a private bank since those loans are held by private entities.
Private lenders have been criticized in recent years for having repayment schedules that are inflexible and have few consumer protections when compared to federal loans. However, banks are becoming increasingly competitive in offering student loans, with private lenders holding about $102 billion of the $1.4 trillion student loan debt.
The CFPB first raised this issue in a 2014 midyear report written on student loan complaints. Over 2,300 complaints were submitted about private student loans and the biggest complaint was that an automatic default was triggered when a the cosigner dies or goes into bankruptcy. At that time, the CFPB suggested these lenders either release the cosigner from the contract or give borrowers the opportunity to find a new cosigner entirely. None of these issues were raised for federal student loans which do not require a cosigner.
These “auto defaults” require borrowers to either pay the full balance due or allow their loans to go into default, which puts their credit at risk and makes future borrowing difficult. Lenders are able to do this in the private student loan market because the loan contracts give them the right to trigger a default even if the borrower is current on their repayments.
This happens because private student loans are sold with other loans, so even though one lender may not use auto defaults there is no guarantee the next lender won’t. Plus, the contracts on these securities often include restrictions that make it difficult for the lender to make exceptions for individual borrowers.
Richard Hunt, director of the Consumer Bankers Association recently sent a letter to CFPB director Richard Cordray stating that 10 banks offering student loans have committed to changing their policy on automatic defaults. Now an automatic default will not be triggered in the event of the cosigner dying or filing for bankruptcy. This policy applies primarily to new loans but Hunt said the banks are committed to applying this same policy to existing loans as well.
Hunt wrote that the member banks, which includes Wells Fargo, PNC Bank, Discover, and Sallie Mae, are committed to offering private student loans with fair terms and conditions that work for both the consumers and the lenders.
On Thursday, Cordray spoke at a consumer advisory board meeting and praised the banks for changing this policy. He welcomed this change for new private student loans and said the CFPB remains committed to overseeing the practice of auto-defaults on existing student loans.