There's a small but tricky provision in many private student loan contracts that could result in big consequences for borrowers, the Consumer Financial Protection Bureau says in a new report.
That provision says if the co-signer of the student loan dies or files for bankruptcy, the loan holder can require complete repayment of the loan.
In other words, a student who is diligently paying a loan on time but whose co-signing parent or grandparent dies could suddenly find herself forced into default on the loan, the CFPB says.
"Students often rely on parents or grandparents to co-sign their private student loans to achieve the dream of higher education," CFPB Director Richard Cordray says in a statement. "When tragedy triggers an automatic default, responsible borrowers are thrown into financial distress with demands of immediate repayment."
Confusion during tragedy
The CFPB report says it has received complaints from consumers about being called to fulfill a loan obligation when a co-signing parent dies.
"Consumers describe their confusion when they receive notices to pay in full since they believed their loan to be in good standing and current," the report says.
The CFPB says it has also received complaints about loan holders trying to collect from a co-signer's estate even after the estate has been closed and settled.
It's unclear how often this type of case occurs.
Richard Hunt, president and CEO of the Consumer Bankers Association, says his association is not aware of any lenders who have a typical practice of accelerating the payment of a loan in good standing upon the death or permanent disability of a co-signer.
"When tragic circumstances occur, CBA members work with their customers carefully and compassionately," Hunt says in a statement, calling it a "rare occurrence" that a lender would call in a loan in good standing because of the death of a co-signer.
"It is common practice for student loan lenders to release co-signers from loan obligations upon the death or permanent disability of a student borrower," Hunt says in the statement.
Lenders have become more cautious about their lending practices, especially in the wake of the financial crisis. Private lenders are increasingly requiring co-signers for student loans, the CFPB report says.
More than 90 percent of new private student loans are co-signed, often by a parent or grandparent, according to a 2012 report on private student loans published by the CFPB and the Department of Education.
"Even when a co-signer is not required, obtaining one can lead to a lower interest rate, since the co-signer is also obligated to repay the loan," the report says.
Bankrate's Debt Adviser, Steve Bucci, wrote recently that it can be difficult to get out of a co-signed loan and that it may be best not to get into a co-signed loan, if possible.
Getting out of a co-signed loan
Indeed, consumers complain to the CFPB about troubles releasing a co-signer on the loan, with required forms sometimes hard to find or to access, or policies that are unclear, the report says.
It noted one instance where a borrower was told by the lender that the co-signer could be released after 28 on-time payments. "After making these payments, the consumer learned that 36 payments were required before a co-signer could be released," the report says. After making the 36 payments, the borrower found out the company policy had changed to 48 on-time payments.
"The CFPB has received complaints from borrowers who have been denied co-signer releases for unknown reasons or for technical reasons that disqualify them," the report says.
Bankrate has tips on how to destroy student loan debt.
Are you a co-signer on any student loans, or do you have a co-signer on your student loans? Share your stories with us in the comments.
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