Compliance Blog

Written by Bernadette Clair, Senior Regulatory Compliance Counsel

The CFPB Student Loan Ombudsman recently issued a mid-year report on student loan complaints.  The report focuses heavily on complaints received related to co-signer issues – primarily difficulties in removing co-signers from private student loans, and private student loan defaults that are automatically triggered by a co-signer’s death or bankruptcy filing. From the CFPB’s press release:

“Among the issues that consumers face:

• Auto-defaults when a co-signer dies: Many consumers assume that the death of a co-signer, often a parent or grandparent, will result in the release of the co-signer’s obligation to repay. But many private student loan contracts provide the lender with the option to immediately demand the full loan balance upon death of the co-signer. These auto-defaults may be occurring when data from probate and other court record scans are matched with a financial institution’s customer database, without regard to whether the borrower is in good standing. These defaults are also typically reported to credit bureaus and negatively impact the credit profile of a borrower.

 

• Auto-defaults when a co-signer enters bankruptcy: Many private student loan contracts also allow the lender to place a loan in default if the borrower’s co-signer files for bankruptcy. Even if the loan was in good standing prior to and while the co-signer is in bankruptcy, borrowers submit complaints detailing how they face auto-defaults, including consequences such as credit damage and frequent debt collection calls.

 

• Obstacles to releasing co-signers from the loan: Borrowers face bureaucratic barriers when seeking to release their co-signer, even though this benefit was advertised before the loan was taken out and could help avoid auto-default. Consumers continue to complain that the rigid and opaque standards for co-signer release make for a mysterious process. For example, consumers note that required forms are often not available on websites or in an electronic form. In addition, servicers do not seem to be proactively notifying consumers about the specific requirements to process a release.”

Despite the lack of information about the actual prevalence of these issues in the student loan market as a whole (see page 9 of the report), and even noting that acceleration and default clauses triggered by the death or bankruptcy filing of a co-signer “may be rational for a creditor,” the ombudsman states that this practice on an otherwise performing loan “warrants review by investors and management.”  The report also goes so far as to comment that “reasonable observers” might ask why private student loan lenders don’t do more before pushing a borrower into default and acceleration, such as determining if a borrower qualifies for a co-signer release, or honoring the existing payment schedule for a designated time period so that borrowers can identify a new co-signer or refinance the loan.

From the report:

“Inclusion of these clauses may be rational for a creditor. 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.⁷

Some industry participants rely on third parties who conduct scans of public records of death and bankruptcy filings, which are then electronically matched to customer records and trigger a default, regardless of individual circumstances. Financial institutions face several risks with this approach.

Reduction of interest income: For a loan where the primary borrower has been making on-time payments for a lengthy period of time, placing the loan in default and demanding the full balance will almost certainly reduce the interest income over the life of the loan.

Reduced recovery of principal: Borrowers that have been making on-time payments for a lengthy period of time may not be able to cover the full amount of the loan immediately after a co-signer’s death or bankruptcy. To the extent that this results in the failure of the servicer or lender to recover the full amount of the loan, or results in higher collection costs per dollar recovered than would have been incurred using the normal payment schedule, automatic defaults may lead to lower recoveries of principal balances.

Poor customer experience: For a borrower who has proven to be a responsible paying customer and is facing the death of a parent or grandparent co-signer, debt collection calls demanding the full balance with limited explanation will probably not be welcomed. This might substantially reduce the willingness of the borrower to pursue other credit products with the financial institution.

Reputation: The deployment of debt collection protocols on an otherwise-performing loan in a time of a family tragedy may give the impression that a private student lender or servicer is inadequately managed or simply unwilling to work constructively with 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. Since lenders and servicers typically have the option to place the loan in default, there are several alternatives worthy of further evaluation that may not only benefit consumers but also lenders and servicers.

•  A private student loan servicer can seek to determine whether the borrower qualifies for cosigner release and maintaining the existing payment schedule would be beneficial for all parties.

 

• The lender or servicer could provide an opportunity for the borrower to obtain another creditworthy co-signer. In many cases, the widowed parent or other elative may be a suitable substitute.

 

• The lender could notify the borrower the existing payment schedule will be honored for a designated period of time before the entire balance is demanded. This would allow the borrower to apply for a new loan (perhaps with a new co-signer such as the widowed parent) or to seek a refinance option with a different lender with new terms.

Reasonable observers might ask why these options are not more commonly employed. We do not know the extent to which lenders and servicers regularly use any of these alternative practices, but acceleration seems to be used by the bulk of industry participants. In addition, pooling and servicing agreements governing the actions of servicers for loans held in securitized trusts may provide additional complexity in these situations.” (My emphasis) (Footnotes omitted).

My take….they don’t know how prevalent these co-signer related problems are in the student loan market, and because they don’t know how often private student lenders try to help out borrowers in these situations, acceleration must be the norm. And apparently it’s not just consumers, but lenders as well, who don’t know how to act in their own self-interests. Laying the groundwork for future rulemaking on private student loan servicing? I’ll let you be the judge of that.