The Consumer Financial Protection Bureau is raising concerns about a caveat in private student loan contracts that allows lenders to automatically put a borrower in default when a co-signer faces certain kinds of hardship.
In a study on student loan complaints released Tuesday, the agency said lenders often demand immediate repayment of a loan when a co-signer files for bankruptcy or dies, regardless of whether the borrower is current on the loan. Borrowers also cited struggles in removing co-signers from loans, which could also trigger defaults.
The agency outlined steps that lenders should take to avoid improperly defaulting on a borrower.
"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 in a press release. "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."
The agency looked at the 2,300 private student loan complaints and 1,300 related debt collection complaints between October 1, 2013 and March 31 as part of its most recent study. Though federal loans made up most of the $1.2 trillion in student loan debt last year, the CFPB said a majority of private loans require a co-signer, which is rare in the federal loan market.
The study said the CFPB has long noticed problems with "auto-defaults" in private student loans. The situation occurs when lenders build in an option in the contract to allow themselves to demand full repayment when a co-signer dies or files for bankruptcy, which triggers default by the lender or servicer.
Borrowers also said they had trouble releasing a co-signer from the contract due to elusive processes by the lender, even when it specifically advertised it as hassle free before the loan was signed. Those issued can also trigger unexpected defaults, the CFPB said.
"Borrowers continue to report to the CFPB about barriers when pursuing a co-signer release. For example, consumers note that required forms are often not available on websites or in an electronic form," said Rohit Chopra, the CFPB's student loan ombudsman, in the report. "In addition, consumers' complaints suggest that servicers do not seem to be proactively notifying consumers about the specific requirements to submit a request for a release."
The CFPB did not release its study until 12:01 a.m. on Tuesday, making it difficult for lenders to respond. However, at least one major bank still involved with student loans said hardship cases like the ones cited by the CFPB happen only rarely.
"Approximately 2% of Wells Fargo student customers experience an unforeseen circumstance that impacts their ability to repay. When this happens, we will exhaust all available options to help the customer through their hardship," said John Rasmussen, the head of Education Financial Services at Wells Fargo, in an emailed response to American Banker. "Wells Fargo does not accelerate debt repayment on the student customer when the co-signer passes away or files bankruptcy."
The Consumer Bankers Association also said it did not appear to be a significant issue, at least among its members.
"It is common practice for student loan lenders to release cosigners from loan obligations upon the death or permanent disability of a student borrower," said Richard Hunt, the head of CBA, in an emailed statement. "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."
In connection with the study, the CFPB also released an advisory for borrowers on how to release a co-signer from a loan as well as steps lenders should take before placing a borrower in default when a co-signer experiences certain hardships. The agency said lenders can honor the existing payments for a certain period of time in order for the borrower to find a new co-signer or refinance the loan if the existing co-signer cannot be released from the loan.
It also cautioned lenders about using a third party to scan public records for death certificates and bankruptcy filings to help expedite automatic defaults.
"While these acceleration options may have a legitimate business purpose, it seems that private student lenders and servicers may not always be acting in their own self-interest by accelerating balances and placing loans in default," Chopra said in the report.
Despite the concerns raised, Chopra said the use of co-signers to receive a private student loan "is a noteworthy feature" in that it helps to lower the interest rate and provides more comfort for investors who purchase securities backed by private student loans.
"However, the practice of accelerating a loan and immediately demanding the full balance upon the death or bankruptcy of a co-signer on a loan that is otherwise performing warrants review by investors and senior management," Chopra said. "We will continue to monitor these co-signer issues carefully and hope to identify opportunities that yield benefits for both industry and consumers."