Student Loan Companies Could Face Enforcement Actions Over Automatic Defaults

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In recent years, countless private student loan borrowers have found themselves placed in automatic default – even if they were up-to-date on payments – when their co-signer died or filed for bankruptcy. Federal regulators now appear poised to rein in this often devastating practice, warning student loan lenders and servicers that they could soon face enforcement action if they continue the practice.

Consumer Financial Protection Bureau student loan ombudsman Seth Frotman, speaking at the Consumer Bankers Association conference on Tuesday, signaled that the Bureau could be ready to bring legal action against companies that improperly place borrowers in automatic default or make it difficult for them to release co-signers from their loan obligations. the Washington Post reports.

As we know, 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 cannot. Back in 2011, about 90% of all private student loans were co-signed, typically by a borrower’s parent or grandparent.

But buried deep within the terms of many private student loans — which often require a co-signer — 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.

Frotman on Tuesday said that examiners for the Bureau identified many ambiguous clauses within loans that failed to spell out the terms of an automatic default or co-signer release. This, he says, could be considered an unfair and deceptive practice in violation of federal law, the Post reports.

In some cases, consumers only discovered that they were placed in automatic default when loan servicers refused to accept payments or they were contacted by a debt collector, Frotman says.

“Simply extending promises to the public that auto-default provisions will not be exercised is hollow and incomplete because future loan holders may decide to enforce these clauses,” Frotman said. “If the status quo persists, I am afraid we will continue to hear from borrowers who are subjected to this practice, and we will be having this same conversation for years to come—a situation I believe none of us want.”

While regulators have previously urged borrowers to seek co-signer releases from their lenders, a CFPB report last year found that’s easier said than done.

In fact, nearly 90% of consumers who have applied for a co-signer release from their private student loan lender were rejected because of unfair industry practices.

That figure was based on the CFPB’s 2014 mid-year report which analyzes more than 3,100 complaints and more than 1,100 debt collection complaints filed between October 2014 and March 2015 related to private student loans, as well as an analysis of lender policies and contracts.

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.

The CFPB’s report found that in most cases, consumers are left in the dark, receiving little information about specific borrower criteria that must be met to obtain a co-signer release.

Many consumers reported being confused about their eligibility for obtaining a co-signer release as well as not understanding why they had been denied.

In a previously reported instance, one borrower told the CFPB 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.

Federal agency warns student loan companies about automatic defaults [The Washington Post]

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