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Bankers ease rules on automatic student loan defaults

Wells Fargo is one of 10 banks that have revised their student loan contracts to help borrowers avoid default. (Nicholas Kamm/AFP/Getty Images)
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Private lenders are revising student loan contracts to ensure people are not placed in default when the co-signer of their loan dies or declares bankruptcy, putting an end to a practice brought to light by the Consumer Financial Protection Bureau.

In a letter obtained by The Washington Post, Consumer Bankers Association President Richard Hunt informed CFPB director Richard Cordray that the 10 member banks who offer student loans, including Wells Fargo, PNC Bank, Discover and Sallie Mae, have changed their policy on so-called auto defaults. All will no longer trigger a default when a co-signer dies, while most will do the same in the event of a bankruptcy; the rest are in the process of following suit. Though the revised contract terms apply to new loans, Hunt said the banks will follow the same policy with existing loans.

“Our member banks remain committed to helping American families finance higher education by offering private education loans with clear, fair and responsible terms and conditions that work for consumers and lenders,” Hunt wrote. “We share our customers’ interest in successfully repaying their loans, including during difficult circumstances, such as the death of a loved one.”

Federal agency warns student loan companies about automatic defaults

Earlier this year, the CFPB warned bankers that they were at risk of breaking the law by automatically placing people who were current on their loans in default. The practice occurs in the private student loan market, where banks and other financial firms provide education financing with loan contracts that give them the right to trigger a default, even if the loan is being paid on time. Auto defaults leave borrowers with no choice but to repay the full balance or ruin their credit, making it difficult to purchase a home or car.

Speaking at a consumer advisory board meeting Thursday, Cordray praised the nine lenders for taking action to help consumers with private loans avoid falling into default.

“For new borrowers, this is a welcome and noteworthy change, which makes new private student loans somewhat safer today than they were last year,” Cordray said. “Of course, we remain concerned about the kinds of auto-defaults that may be triggered on older loans, and we will be scrutinizing those practices wherever they may be occurring.”

The consumer bureau urged lenders for almost three years to strip the clause from their contracts but was met with resistance, though many said they would not engage in the practice. Without changing the promissory note, lenders were leaving people vulnerable in the event of their loan being packaged into a security sold to investors, what’s known as securitization.

In the aftermath of the financial crisis, lenders readily required a co-signer to make the debt more appealing for securitization. Having parents or grandparents shoulder the legal responsibility of a loan can result in a lower interest rate because the co-signers are obligated to repay the loan if the borrower does not. But the contracts on those securities often come with restrictions that could make it difficult for the company servicing the loan to make adjustments for individual borrowers.

By revising the promissory note, Cordray said, “even when new loans are sold or securitized, the terms of the loans will protect borrowers from these harmful practices in the future.”

U.S. agency urges private lenders to ease automatic default rules on student loans

The agency first highlighted the problem in its 2014 midyear report on student loan complaints. Chief among the 2,300 complaints about private student loans submitted to the bureau was the triggering of a default by the death or bankruptcy of a co-signer. At the time, the bureau recommended lenders give borrowers the chance to find another co-signer or release the co-signer from the contract.

Private lenders hold only 7.5 percent, or about $102 billion, of the $1.3 trillion in outstanding student loan debt, according to Measure One, a company that tracks private student loans. They have drawn criticism for having inflexible repayment terms and weaker consumer protections than federal loans, but in recent years, more banks, credit unions and other financial firms that provide education loans have been offering competitive terms.

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