By Richard Pérez-Peña
For students who borrow on the private market to pay for school, the death of a parent can come with an unexpected, added blow, a federal watchdog warns. Even borrowers who have good payment records can face sudden demands for full, early repayment of those loans, and can be forced into default.
Most people who take out loans to pay for school have minimal income or credit history, so if they borrow from banks or other private lenders, they need co-signers — usually parents or other relatives. Borrowing from the federal government, the largest source of student loans, rarely requires a co-signer.
A report released Tuesday by the Consumer Financial Protection Bureau points out a little-noticed provision in private loan contracts: If the co-signer dies or files for bankruptcy, the loan holder can demand complete repayment, even if the borrower’s record is spotless. If the loan is not repaid, it is declared to be in default, doing damage to a borrower’s credit record that can take years to repair.
The bureau said that after a co-signer’s death or bankruptcy, some borrowers are placed in default without ever receiving a demand for repayment. The agency did not accuse loan companies of doing anything illegal.
Rohit Chopra, the bureau’s student loan ombudsman, said he did not know how common the practice was, but that a steady stream of consumer complaints indicated it was becoming more frequent. He also said companies appeared to be doing it more or less automatically, combing public records of deaths and bankruptcies, comparing them to loan records and generating repayment demands and default notices.
What makes the “auto-defaults” odd is that they do not benefit the loan servicers and lenders, who usually go to some lengths to avoid putting loans into default. A number of investment funds sell securities backed by student loans, and Chopra said it was not clear whether forcing early repayment and defaults might be tied to the terms of those securities.
“The ways in which they’re exercised don’t seem to be in the best interests of their companies or the best interests of the borrowers,” he said. “It doesn’t seem that there is a thoughtful business decision.”
He would not name specific companies involved, but said, “Most of the larger players in the industry do have contracts that contain these options.”
Americans owe about $150 billion in student loans to private lenders. Both the government and private lenders usually transfer their loans to loan servicing companies.
The largest private lender, and by far the largest servicer of both government and private loans, is Sallie Mae, which did not respond to calls and emails seeking comment on Monday.
Borrowers often can have their loans released from the co-signer requirement if they have a few years of earnings and credit history, or have the loans transferred to a new co-signer. But the consumer bureau said that borrowers were not often aware of those options, and that even if they were, the loan companies made it difficult to exercise the options.
Chopra urged people to take advantage of such provisions when they could, adding, “Borrowers need to be aware that these defaults can seriously impair their credit profile,” making it hard to start a business, or buy a house or a car.
In the last decade, private student lending mirrored the mortgage industry: Lenders were willing to do business with many high-risk borrowers at high interest rates, partly to satisfy the demand for loan-backed securities. But the companies became more cautious after the recession hit and defaults soared, and they went from requiring co-signers on 67 percent of loans in 2008 to 90 percent in 2011.
As parents and grandparents age, Chopra said, problems with sudden defaults and repayment demands are likely to get worse.