NEW YORK (MainStreet) — You got a private student loan, co-signed by a relative or guardian, that you think will back you up in a pinch. But what happens if that person goes bankrupt or dies? The loan is on you--and it's on you fast.
The Consumer Financial Protection Bureau (CFPB) released a report last Tuesday that spelled out the details on student loan auto-defaults, a worst-case scenario that has become an increasing source of complaints made to the federal consumer watchdog.
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The "auto" in auto-default kicks in when the demand for full repayment is made by the lender following the death or bankruptcy of the co-signer. Loans can auto-default even if the borrower was current on payments. When the borrower can't make the full payoff in one shot--a typical outcome--credit scores get whacked, home mortgages and car loans fall off the table.
This non-solution benefits no one; lenders typically start the process of putting a loan into default only as a last resort.
The vast majority of federal loans are made by the Department of Education and don't require co-signers — PLUS Loans are an exception. The private student loan market, with a debt total of about $150 billion, is where the auto-default phenomenon is found. Banks are major players —including Discover, Wells Fargo and PNC Bank. JP Morgan Chase and Citibank have begun exiting the student loan market while continuing to collect on existing loans. Newark, Del.-based Sallie Mae is the biggest private lender and largest servicer of private and federal loans.
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"Private student loans can sometimes take many years to pay off, and parents or grandparents may be unaware that their own financial distress or death can lead to a sudden default and demand for payment in full," said Rohit Chopra, CFPB student loan ombudsman Rohit Chopra, during a call with journalists a week ago.
A co-signer's obligation can vary from loan to loan. Lenders will typically release a co-signer from the loan agreement if the borrower has made consistent on-time payments. Yet some lenders and loan servicers, who manage and collect the actual payments, will often make added demands before they let the co-signer off the hook. They might run credit checks, demand proof of graduation, employment status and salary levels—or all of the above.
In its report on student loan complaints, the CFPB found that complaints have surfaced in over 90% of private, co-signed loans. Defaults that were the result of the bankruptcy or death of a co-signer were among the most frequent complaints.
—Written by John Sandman for MainStreet