When a tragedy befalls a loved one, the last thing you want to hear is more bad news. But unfortunately, some private student loan lenders have a policy called “auto default” that can turn bad news even worse.
According to the Consumer Finance Protection Bureau (CFPB), a private student loan can go into default if a responsible borrower’s cosigner undergoes bankruptcy or dies. The borrower may wind up with the shocking revelation that they need to pay the entire balance of the loan within 30 days or risk having a defaulted private student loan. This is known as auto default.
Like all loan defaults, auto default can destroy your credit and make it difficult to access loans, rent an apartment or even get a new job.
Such a lending policy seems arbitrary and unprofitable, but it exists. In March 2016, the CFPB reported that their examiners put a stop to unfair auto defaults from one or more servicers because their loan contracts were ambiguous.
If you’re a borrower with private loans, these are the facts about auto default that you need to know.
How private student loans enter auto default
More than 90% of private student loans require a cosigner to back the loan, according to a 2017 CFPB report. Cosigners enable you to access lower interest rates and greater amounts, since the cosigners promise to pay back the loan if you default.
Because private loans are contingent upon cosigner creditworthiness, many lenders retain clauses that allow banks to call a loan in full if the cosigner goes into bankruptcy or dies. Although some banks say they do not intend to trigger this option, the CFPB reports that many exercise this option when the loan has been sold or is part of a securitization trust.
Depending on the circumstances, however, calling the loan may be illegal. However, you may feel there’s little recourse when you’re told your loans must be paid within 30 days.
How to prevent auto default
The best way to prevent an auto default on your private student loan is to release your cosigner as soon as you are able to do so. Many student loan servicers allow cosigners to be released from a loan after a certain number of on-time payments or with a qualifying credit score. But unfortunately, the Consumer Federal Protection Board found in 2015 that more than 90% of all attempts to release private student loan cosigners were rejected.
As a result, the CFPB recommends using its sample letter to write to your lender and ensure that you receive complete information about your eligibility to release your cosigner. In particular, if your cosigner is in poor health or has financial trouble, you should double down on your efforts to release them.
If you are ineligible for a cosigner release, you should have the option to change cosigners if you believe that your current cosigner puts your credit score or payment schedule at risk. But note that eligibility requirements for changing cosigners vary from lender to lender and even from contract to contract.
Often, the best way to release a cosigner from a private student loan is to modify the loan or refinance it. Private student loans are notoriously difficult to modify, but refinancing with a different company may be possible for people with good to excellent credit.
What to do if you enter auto default on your private student loans
Though the CFPB has proposed legislation to make lending practices more transparent, you must act quickly if your private student loan is in default, lest it destroy your credit.
If a collections agent informs you that your loan is in default, you should request a verification of debt. The collector must provide information about the loan balance and the original lender, and you can then use that information to reach out to the lender directly. Do not attempt to negotiate with the collector, unless you’re prepared to pay the sum since they cannot restore your credit.
If the bank informs you about the auto default, then you should contact them to attempt to reverse the default and modify the loan. Under many circumstances, both the borrower and the bank are likely to come to the conclusion that modifying the loan may be in the best interest of both parties.
Once you are in contact with a bank, then you should propose mutually beneficial solutions like modifying a loan to include a cosigner release option, allowing for a period of time to find a new cosigner or enabling a refinance.
If you cannot convince the private lender to modify a loan and reverse a default, then you should submit a complaint to the CFPB. The bureau is tasked at working on behalf of consumers to ensure prompt responses and resolution.
In some cases, the CFPB can work quickly enough for you to avoid default. However, if you are put into auto default, then you will need to clean up your credit. To determine whether anything needs to be done, first check your credit score, and then access your full credit report (available for free at AnnualCreditReport.com) to see if there are any negative marks on there. If the student loan entered default, then that will be present on the credit report, and the CFPB can work with you and the lender to be sure that the negative information is removed.
Will auto defaults stop?
Even with proposed reforms in the private student lending market, you remain at risk for auto defaults as long as you have a cosigner on your loan. The best way you can protect yourself from an auto default is by removing your cosigner or refinancing your loans without a cosigner.
The CFPB works to protect consumers through action and reform, but you put yourself in a stronger position when you proactively work to avoid lending practices such as auto default.