Some private student loan borrowers are placed in automatic default when a co-signer dies or declares bankruptcy, even if the borrower has made payments on time. In a new report, the Consumer Financial Protection Bureau noted that “auto defaults” force borrowers to repay the full loan balance immediately or suffer damage to their credit. Among the 2,300 complaints about private student loans to the CFPB in the past five months, one of the most common issues was default triggered by the death or bankruptcy of a co-signer. The CFPB recommends that lenders consider alternatives, such as giving borrowers time to find another co-signer.
Having a co-signer can lower the interest rate on a private student loan because the co-signers must repay the loan if the primary borrower does not. Lenders usually release a co-signer from the agreement if the borrower has made consistent, timely payments; but some lenders and servicers force borrowers through extra requirements to get a release -- such as proof of graduation, student transcripts, or evidence of employment or salary. Rohit Chopra, student loan ombudsman for the CFPB, says strict co-signer terms may make the debt more attractive for securitizing the loans for investors. The contracts on those securities, in turn, may make it difficult for loan servicers to make adjustments for individual borrowers.
Although private student loans account for only $150 billion of the $1.2 trillion in outstanding student loans, they represent a disproportionate share of consumer complaints. While the private market is dominated by major financial institutions such as Citigroup, JPMorgan Chase, and Wells Fargo, most complaints to the CFPB were about loan servicers such as Sallie Mae and American Education Services.