Friday, August 22, 2014

The saddest way to default on your student loan

Mourners in Arlington Cemetery. A parents' death can place student loan borrowers in default. Michael Reynolds-Pool/Getty Images

Young adults dealing with the death of a parent or grandparent can get an unpleasant surprise: a bill for their entire outstanding student loan, paid in full, even if they're up to date with payments.

Nearly all new private student loans now have a cosigner — a parent, grandparent or other adult taking out the loan jointly with a student. In some cases, this is a bank requirement for taking out the loan in the first place; in other cases, a cosigner with good credit makes it easier for a student to get a good interest rate.

But there's a catch. If anyone whose name is on a private loan dies or declares bankruptcy, the lender can put the loan in default and demand payment in full. If a loan is in default, it makes it easier for lenders to collect on the unpaid balance. Default can hurt the survivor's credit score, and it's particularly unfair if the loan actually was being repaid.

The Consumer Financial Protection Bureau has been getting complaints about the practice. Rohit Chopra, the agency's official advocate for borrowers, writes in a new report today that this isn't just bad public relations for banks; it's a bad financial model, too. If the cosigners' survivors really do pay back the entire balance when asked, that means the bank will get less in interest than they would have if repayments proceeded as normal.

Putting a grieving borrower in default also creates a "poor customer experience," Chopra writes with considerable understatement. "For a borrower who has proven to be a responsible paying customer and is facing the death of a parent or grandparent co-signer, debt collection calls demanding the full balance with limited explanation will probably not be welcomed."

Federal student loans, which make up more than 80 percent of all outstanding student debt, don't have a credit check for students and don't have cosigners.

One solution for private loans: releasing cosigners from their obligations after borrowers make a certain number of payments. But Chopra notes that many student lenders don't tell borrowers this is an option at all.

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