Student loan debt has been a discussion point among policymakers recently, as both legislators and borrowers push for loan reform.
The Consumer Financial Protection Bureau (CFPB) is the latest agency to voice its concerns regarding how student loans are handled. In its mid-year update on student loan complaints, the CFPB spoke at lengths about automatic default actions, which occur with some lenders when the loan cosigner - often a parent or grandparent - dies. Even borrowers who have been current on their payments receive notices stating that their loans are in default.
"Some consumers assume that death of a co-signer will result in a release of the co-signer's obligation to repay," the report said. "Consumers describe their confusion when they receive notices to pay in full since they believed their loan to be in good standing and current."
Furthermore, the CFPB has received complaints about debt collectors threatening to place liens on the property or other assets if the decedent's family members or estate administrators don't immediately pay the loan in full. Some debt collectors for private loan providers have even attempted to collect from a cosigner's estate after it has been closed and settled.
Automatic defaults following cosigner bankruptcy
In addition to a cosigner's death prompting an auto default for some borrowers, some students reported notices following their cosigners' filing for bankruptcy protection. This has occurred even if borrowers were current on their payments. Also, services such as online payments, receipt of billing statements and additional loan information are typically suspended during their cosigners bankruptcy hearings.
These defaults are often reported to credit agencies, negatively affecting the borrowers' credit profiles despite their timely payments. This results in difficulties obtaining employment and other forms of credit.
Cosigners growing in number and leading to more complaints
The CFPB noted that issues relating to cosigners are common among their complaints, and chose to focus on these problems as a result. More student loans are originated with cosigners, as the Department of Education and the CFPB found that the proportion of borrowers having a cosigner rose from 67 percent in 2008 to 90 percent in 2011.
Many loan servicers advertise means of releasing cosigners from their obligation once certain terms are met, a factor that makes having one - in addition to lower interest rates - attractive to borrowers. However, this advantage is not often realized, even with account holders meeting the pre-determined number of on-time payments, prompting more borrower complaints.
Among the grievances listed by the CFPB, one notable example from the previous year's mid-year report showed that some lenders continually extend the required period of on-time payments before a cosigner would be released. Lenders are also cited as not properly notifying borrowers regarding the terms for release or making the necessary request forms for such an action easily available on their websites or electronically.
Another unclear requirement is the minimum credit standards, such as the credit credit score threshold for releasing a cosigner. Many complaints said these details were unavailable, though credit checks are often required before a cosigner is released. At times, no clear criterion is given for why a request is denied or technical reasons bar a borrower's eligibility. The CFPB asserted that these barriers often lead to automatic defaults down the line.
CFPB recommends lenders consider alternatives
Rather than placing loans in default following a cosigner's death or bankruptcy filing, the CFPB suggested that lenders employ other strategies. One recommended alternative was giving borrowers time to find a new cosigner should their loan be placed in automatic default.
Risks to financial institutions
Rohit Chopra, student loan ombudsman for the CFPB, noted that these practices hurt lenders as well as borrowers.
"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.
He cited four risks lenders assumed by automatically placing loans in default:
- Customers are likely to respond negatively, especially when faced with a call demanding full repayment of a student loan in the face of a family death or financial crisis. In the future, the borrower may seek other lenders for credit services.
- Additionally, a poor customer experience could lead to a negative reputation for the lender, as employing debt collectors at such a time "may give the impression that a private student lender or servicer is inadequately managed or simply unwilling to work constructively with borrowers," Chopra said.
- In regard to revenue, he said that placing a loan in default for a borrower that typically makes on-time payments will likely lead to a loss of interest earned over the life of the loan.
- Furthermore, it is unlikely that such a borrower will be able to repay the loan in full immediately. This could result in the lender not recovering the full amount of the loan. There could also be higher collection costs per dollar recovered.