Student Loans, Auto Default Clauses: or, Everything Old is New Again

I was recently discussing issues with student loans, and private student loans in particular, with a staffer for one of my Congressmen. The staffer said something along the lines of, but isn’t student loan debt good debt? My response? Student loans, especially private student loans, may be the worst kind of debt – even worse than credit cards. His expression was fun. He did keep his coffee off his tie, though. Points for that.

There are a lot of reasons I’m not just real gung ho on student loans – especially private student loans. One of those reasons has been getting some press this week. Here is a link to a NY Times article on auto default clauses in private student loans. There have been several others recently, but this was the first one I saw.

http://m.washingtonpost.com/business/economy/us-agency-urges-private-lenders-to-ease-automatic-default-rules-on-student-loans/2014/04/21/d06adeee-c97f-11e3-95f7-7ecdde72d2ea_story.html

Most private student loans require a co-signer, usually a parent or grandparent. Many of those loan documents also include language known as an auto default clause. An auto default clause means that the loan is deemed to be in default if a particular event happens – EVEN IF PAYMENTS ON THE LOAN ARE CURRENT. The current press is about auto default clauses that trigger an event of default if the co-signer files for bankruptcy or dies.

To be quite blunt:
Bad news – Dad is dead.
More bad news – your student loans are now being reported in default to the credit reporting agencies, even though you’ve never missed a payment.

There is a good argument that the an auto default triggered by a bankruptcy filing of the co-signer is unenforceable, and I foresee some interesting litigation on that issue. The death of the co-signer, though, is going to be valid unless some lawyer who is far more creative than I am comes up with something I haven’t thought of.

A lot of the NY Times article referenced above has to do with encouragement from the Consumer Financial Protection Bureau for lenders (or, more accurately the loan servicers) to find ways to avoid placing otherwise performing loans into default status. There are a number of problems with that encouragement. First of all, it is just that, encouragement. I am not aware of any authority the CFPB has to require anything. Second, the same problem is showing up here that we had getting loan modifications during the mortgage crisis. Most of these loans have been securitized. The entity that the borrower deals with (Sallie Mae, AES, etc.) isn’t actually the lender. They are the servicer, they just manage the loans on behalf of the ultimate investors, and they do so pursuant to the terms of a contract that limits their ability to modify the loans.

Part of the securitization process is taking a large body of loans, pooling them together and using their income stream to support payments to investors who invest in the large pool. To do that, the individual loans that go into a pool must share certain qualities; and one of the qualities that makes a pool of loans like this more attractive to investors is the presence of co-signers – or, having more than one person responsible for repaying the loans. So, encouragement from the CFBP is nice, but I don’t think I will hold my breath on seeing any real changes here.

Of course, the real victims are the college graduates who are making their loan payments and then find out that the interest rate on a car loan is going to be sky high or they can’t qualify for a mortgage; why? Because their student loans are in default – yea, the ones they are PAYING every month.

I’m sorry, but that sucks.

They took out those loans (for the most part) when they didn’t have a lot of experience with financial products. Their parents (or grandparents) signed. Their school told them to sign. So, they signed. Even if they read the fine print, they very well might not have realized with an automatic event of default means. Their school should have. Their parents (or grandparents) should have, and they might have; but they saw no other (or no better) way to pay for college.

There isn’t much I can do about people dying; but filing bankruptcies for people who might have co-signed student loans is part of my job. I’m currently thinking through some ideas with other attorneys to mitigate the consequences of a bankruptcy filing when the debtor has co-signed private student loans. Keep in touch.

Elaine

 

 

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Categories: Bankruptcy, Consumer Credit, Credit Reports, Student loans | Tags: , , , , , | Leave a comment

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