Proposed Bill Would Eliminate Automatic Default For Private Student Loans

Between finding a job, finding a place to live, paying bills, and generally being an adult for the first time in their lives, many recent college graduates face a slew of challenges. One thing they shouldn’t have to think about is automatically defaulting on a student loan when a co-signer dies or files for bankruptcy. Today, legislators proposed a bill to protect consumers from getting stuck in this trap.

New York Representative Tim Bishop proposed an amendment to the Truth in Lending Act that would establish requirements for the treatment of a private education loans upon the death or bankruptcy of a co-signer of a loan.

“The practice of automatically defaulting on student loans without notice to the student or an opportunity to correct the situation is deplorable,” Rep. Bishop says in a news release on his website. “We need to make it easier for students to access higher education, not pull the rug out from under them when their circumstances change through no fault of their own.”

Known as the Protecting Students From Automatic Default Act of 2014, the proposed amendment adds a section to the current Act that outlines duties a servicer should follow upon learning of a co-signer’s death or bankruptcy.

In general notwithstanding any provision in a private education loan agreement, a private educational lender shall immediately notify a borrower if, upon receiving notification of the death or bankruptcy of a co-igner who is jointly liable for the private education loan, such lender deems the borrower to be in default, changes the terms of the loan, or accelerates the repayment terms of the loan.

Additionally, the proposed bill establishes a timeline in which a borrower can identify a new co-signer before facing default.

A private educational lender shall provide a period of time of not less than 90 days, beginning on the date such lender issues the notification described in subsection (a), for a borrower to identify a new co-signer for the loan. Such lender shall retain the right to renegotiate loan terms based on the creditworthiness of the new co-signer.

Last week, the Consumer Financial Protection Bureau released a report [PDF] citing automatic defaults as a significant source of complaints from borrowers of private student loans.

In 2011, nearly 90% of all student loans were co-signed, typically by a borrower’s parent or grandparent. The practice of employing a co-signer can often lead to lower interest rates on student loans, because the co-signer is on the hook to pay the loan if the borrower can not.

While many loan issuers advertise the option of releasing a co-signer from their obligations after a borrower meets certain requirements — often making a certain amount of on-time payments — consumers have reported it’s not an easy task.

In one case, a borrower reported that at the time of origination, the lender stated they could release his co-signer after he made 28 on-time payments. however after making those payments, the borrower learned that 36 payments were required. After making the additional payments, he was told that 48 payments were now required.

In other instances, borrowers reported that required forms were not available on websites or in electronic form. The inability to release a co-signer can often lead to unintended consequences for a borrower.

The Protecting Students From Automatic Default Act of 2014 was assigned to the House Financial Services Committee for review.

Want more consumer news? Visit our parent organization, Consumer Reports, for the latest on scams, recalls, and other consumer issues.