The Consumer Financial Protection Bureau (CFPB) is giving student loan companies a strict warning when it comes to collecting from borrowers in default when the co-signer of their loan dies or files for bankruptcy. These “auto defaults” leave borrowers with no choice but to repay the loan in full or ruin their credit, making it difficult to purchase a home or car.
This practice often occurs in the private student loan market, where banks and other lenders provide educational financing with loan contracts that give them the right to trigger a default even if the loan is being paid on time. Now the student loan companies are at risk of breaking the law, if they continue with this practice.
When parents or grandparents take on the legal responsibility of a loan, students can get lower interest rates because the co-signers are obligated to repay the debt if the borrower does not.
Lenders often require a co-signer to make the debt more attractive to investors. They will typically release a co-signer from the loan agreement if the borrower has made consistent on-time payments. However, some lenders and loan servicers make this process difficult by having the borrower jump through hoops to get such a release, according the CFPB. They often request proof of graduation, transcripts, employment or salary, and even conduct credit checks.
The bureau first brought attention to auto defaults two years ago after receiving complaints from consumers whose loans were placed in default because of the death or bankruptcy of a co-signer.
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