The Consumer Financial Protection Bureau’s (CFPB) April 2014 update on student loan complaints highlights a particularly insidious problem in the private student loan industry—the practice of “auto default” in which borrowers in good standing are immediately placed in default on their loans after the death or bankruptcy filing of a co-signer. This occurs even when borrowers are current and in good standing on their loans. Many are suddenly in default after making payments for years.
Since about 90% of private student loans have co-signers, these practices impact nearly all private student loan borrowers. Borrowers not only face the death of a family member in many cases, but also threats from collectors to place liens on property or other assets if they do not immediately pay the loan in full. Most lenders also report the default to credit bureaus, seriously damaging a borrower’s credit score. Again, these are borrowers who are current and in good standing on their loans, suddenly in default in some cases after making payments for years.
This document gives some examples of the clauses the lenders rely on to trigger default in these circumstances.
The first document, a private Discover student loan from 2008 states in the “Whole Loan Due” clause (see box) that the entire outstanding balance on the loan will be due immediately at the lender’s option without any prior notice to the borrower and without any right to cure, except where required by law. Default can occur, among other reasons, immediately upon the death of the student or cosigner.
The second document, a Sallie Mae Signature loan from 2003 with Citizens Bank as the lender has a similar clause. Although little consolation, Sallie Mae at least agrees to give the borrower notice of default if the borrower OR co-borrower dies. There is also a “universal default” clause in this document starting that the entire private loan will become due if the borrower is in default on any other loans she may have with Sallie Mae, or “…on any loans I may have with you in the future.” Further, the document states that a failure to receive a statement does not relieve the borrower of the obligation to make payments.
The third document from Key Bank also requires notice to be given, but allows the lender to declare the loan in default if the borrower dies or becomes insolvent or in the lender’s judgment, there is a “significant lessening of my ability to repay any Loan subject to the terms of this Note. “ This is an extremely subjective standard, as we discussed in detail in our 2008 report on predatory private student loans.
It is unclear why a lender would engage in these practices. Accelerating a loan when a borrower is current cuts off the lender’s revenue stream. The CFPB report includes some possible reasons, including that some lenders rely on third parties to conduct document searches of death and bankruptcy records. In these cases, the lenders tend to automatically accelerate the loans without even looking into the individual borrower’s circumstances.
The report lists some alternative actions lenders could take. At a minimum, lenders should consider individual circumstances before automatically declaring defaults. According to the CFPB, lenders might also give borrowers an opportunity to obtain a new co-signer. This CFPB advisory provides information to borrowers about avoiding these potential problems. Borrowers should look into what’s called a “co-signer release.” This option can avoid surprise default and both borrowers and co-borrowers can benefit. Since many lenders do not tell borrowers when they are eligible to have a co-signer released, the CFPB provides information about how to ask your lender for this release.
We share the CFPB’s concern about these private lender practices that compound the pain for borrowers. This certainly warrants further review, as the CFPB concludes. Closing the door on borrowers in good standing is yet another way that private student lenders fail to do the right thing for borrowers. Too often, the lenders feel empowered to act in these harmful ways and fail to provide relief because they know that it is so difficult for borrowers to get bankruptcy relief. In addition to tackling the “automatic default” problem head-on, Congress must also act to restore bankruptcy relief for student loan borrowers.