July 13, 2014

Am I Completely Screwed If My Student Loan Co-Signer Dies?

Imagine this scenario: You’ve been out of college for several years, have a good job and you have no problems making your student loan payments in full and on time. Then tragedy hits; your parent dies or declares bankruptcy. If this loved one was a co-signer on your student loan, this change can trigger an often-overlooked clause that allows the lender to claim you are in default on your loan, potentially wreaking longterm havoc on your credit and finances.

• Many private student loans have “automatic default” clauses that are triggered when a loan’s co-signer dies or declares bankruptcy.
• Even if the loan is in good-standing and the borrower is financially stable, the loan can be called in and the default reported to credit bureaus, tainting the borrower’s credit.
• Some lenders allow for borrowers to release co-signers after certain requirements have been met, but they don’t make it easy.
• If a lender doesn’t have a co-signer release clause, it may allow you to appeal to be the sole name on the loan, but you often have to make this appeal within a limited time window.

With tuition rates outpacing inflation, a growing number of students have had to turn to student loans. Borrowers also increasingly took out private loans to make up difference that federal loans won’t cover. In order to obtain these loans or to minimize the interest rates, many private loans are co-signed by parents or other family members.

According to the Consumer Financial Protection Bureau, whose April 2014 report listed auto-defaults as a significant source of complaints from borrowers, nearly 90% of private student loans were co-signed in 2011.

So, how does an option intended to help student borrowers with no or poor credit histories turn into a credit-wrecker?

If you have a private student loan, you may not know that buried deep within the terms of that loan there may be a small but poisonous provision that permits the lender or loan servicer to place a loan in default, or accelerate the full balance of the loan, upon the death or bankruptcy of a co-signer. And it doesn’t matter whether the loan is in good standing or if you are financially stable.

Deanne Loonin, director of the National Consumer Law Center’s Student Loan Borrower Assistance Project, tells Consumerist that her organization has been trying to spotlight this hazard to borrowers.

“There’s no standard language required so there are variations on the theme,” explains Loonin, “but that’s where it originates.”

The Student Loan Borrower Assistance Project offers examples of what these kinds of provisions may look like.

How Do Lenders Decide To Default?

They are called “automatic defaults,” but how automated are the systems that determine whether or not your loan is suddenly due?
The 3 Models For Loan Servicing

There are generally three ways in which your private student loan can be owned and serviced:
•1: The lender both owns and services the loan. Such loans tend to offer the most flexibility in terms of automatic defaults.
•2: The lender owns the loan, but a third party services it. Adds another layer of bureaucracy; servicer may be required to follow lender’s rules on auto-defaults.
•3: The loan has been securitized and is now part of a larger pool of loans that has been sold off to investors. The servicer has minimal ability to bend the rules.

Because each lender is different in the way it handles auto-defaults, there is no hard-and-fast answer to that question.

According to the CFPB report, some industry participants rely on third parties that scan public records of death and bankruptcy filings. Those records are then electronically matched to customer records and used to trigger the default. Lenders who rely on this process often do not take into any extenuating circumstances into consideration before hitting the default button.

That isn’t always the case, explains the CFPB’s Rohit Chopra (who previously answered a bunch of Consumerist readers’ student loan questions).

Banks that actually own the loans they service are generally able to exercise more discretion on defaults, explains Chopra. But even that leeway is subject to pooling and servicing agreements, which lay out rules that govern bundled securitized loans and can often be restrictive.

Bad for the Banks

While the auto-default rules are intended to protect lenders from being stiffed by a borrower who can’t repay without a co-signer, Chopra explains that these provisions can lead to outcomes that are not in the best interest of the financial institution or the borrower.

“For many lenders, they might find that it doesn’t make sense to demand a full balance on a loan when a person is paying on time and has been for a significant period of years,” Chopra says of automatic default clauses.
4 Ways Auto-Defaults Can Backfire On Banks

Reduction of Interest Income: Placing a loan that is in good-standing in default and demanding the full balance will likely reduce the interest income over the life of the loan.

Reduced Recovery of Principal: Automatic defaults may lead to lower recoveries of principal balances because a borrower is unlikely to be able to cover the entire cost of the loan immediately; additionally, the servicer could lose money by using collection agencies.

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.

Damage to 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.

Damage That Can’t Be Undone?
Image courtesy of Tim Schreier
Section Permalink Bookmark Section

While auto-defaults may look bad for banks, the consequences for borrowers are much worse and longer-lasting, even though the borrower may have done nothing to cause the problem.

Student loan servicers report automatic defaults to credit bureaus, negatively impacting the borrower’s credit profile, which, in turn, makes it challenging to qualify for future loans, obtain credit, or even get a job.

consumerist.com

The above statements do not represent those of Weston Legal or Michael Weston and they have not been reviewed for accuracy. The statements have been published by a third party and are being linked to by our website only because they contain information relating to debt. Nothing in this article should be construed as legal advice given by Weston Legal or Michael Weston. To view the source of the article, please following the link to the website that published the article. Articles written by Michael W. Weston can be viewed here: To report any problem with this article please email studentloan@westonlegal.com