Before You Borrow: What You Need to Know About Student Loan Auto-Defaults

Acting as a cosigner for your child's student loans may seem like a great way to help him or her pay for college, but some lenders make it more difficult than others. Read on for some advice on helping your child avoid "auto-defaults."

With the best of intentions, many parents and grandparents of college-bound students help them pay for school by cosigning on their student loans. A cosigner provides a bit of a safety net for both the lender and the student taking out the loan. Students with little or no credit history will have an easier time obtaining a loan—and may receive a better interest rate—if they have a cosigner. And banks can feel more comfortable lending to a student who has a creditworthy cosigner who will be equally responsible for the debt. Unfortunately, however, there are some circumstances in which your child could be blindsided and required to pay off the loan all at once.

What are “auto-defaults”?

While cosigning for your child or grandchild’s student loans may seem like a simple act of benevolence, some surprising tactics among lenders have come to light recently. Some banks and other student loan lenders implement “auto-defaults,” in which students are required to pay off their debt if their cosigner passes away or files for bankruptcy—even if they’ve been making all of their payments in full and on time.

The Consumer Financial Protection Bureau (CFPB) recently published a consumer advisory warning borrowers of this practice.  While they noted that the majority of student debt is comprised of federal loans, which students generally take out on their own, many students do end up taking out private loans, which almost always require a cosigner.

In addition to auto-defaults resulting from a cosigner’s death or bankruptcy, the CFPB also reported that many borrowers have faced challenges in getting lenders to release cosigners from loans, which would help them avoid auto-defaults.

Lenders may employ this practice as a means of making a claim against a cosigner’s estate in an effort to pay off the loan, but for recent college graduates, auto-defaults are stressful at best and financially devastating at worst.

“Students often rely on parents or grandparents to cosign their private student loans to achieve the dream of higher education. When tragedy triggers an automatic default, responsible borrowers are thrown into financial distress with demands of immediate repayment,” said CFPB Director Richard Cordray in the Bureau’s report. “Lenders should have clear and accessible processes in place to enable borrowers to release cosigners from loans. A borrower should not have to go through an obstacle course.”

How you can protect your child from auto-defaults

If you’re planning on acting as a cosigner for your child’s student loan, make sure you’ve read all the fine print and are aware of all the lender’s policies. Once your child has graduated and demonstrated that he or she is fully capable of making loan payments, he or she can begin the process of obtaining a cosigner release. As noted in the CFPB’s advisory, bureaucratic red tape can make that a difficult process, but it’s not impossible.

Securing a cosigner release will benefit both you and your child because it will help him or her avoid an auto-default while also getting the debt out of your name. Find out what the lender’s cosigner release policy is before you take out a loan. Once it goes into repayment, make sure your child asks the lender when the loan will be eligible for a cosigner release (lenders aren’t always up-front about the timeline, so it’s important to be proactive and inquire). To help you and your child navigate the process, the CFPB has put together some sample letters that you can use when contacting your lender.

Cosigning your children’s student loans can be an excellent way to help ensure they receive the college education they deserve. Just be sure you’ve researched several lenders and understand their policies before putting your John Hancock on the paperwork (and don’t forget: you can help your child avoid debt altogether with the CollegeXpress scholarship search!).

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About Stephanie Farah

Stephanie Farah

Stephanie Farah is a former writer and senior editor for Carnegie and CollegeXpress. She holds a BA in English from the University of Texas at Austin and a master's in Journalism from the University of North Texas. At various times, she has been an uncertain undergrad, a financial aid recipient, a transfer applicant, and a grad student with an assistantship and a full ride. Stephanie is an avid writer, traveler, cook, and dog owner. 

 

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