Student loan companies: Deceptive or just confusing?

The Consumer Financial Protection Bureau on Tuesday said student loan companies could be breaking the law with some of their debt collection practices. 

A federal consumer advocacy agency is asking private student loan companies to stop using some confusing fine print to deceive borrowers. 

The Consumer Financial Protection Bureau (CFPB) on Tuesday challenged lenders who are “auto-defaulting,” demanding immediate and full repayment of a loan if a co-signer dies or files for bankruptcy, even when the loan is current and being paid on time. This practice unfairly over-burdens borrowers and could damage their credit profiles, says the bureau.

Loan contract clauses related to auto-defaults were unclear, which could be considered unfair and deceptive, and thus, illegal, said CFPB student loan ombudsman Seth Frotman at a Consumer Bankers Association conference Tuesday.

The CFPB is also concerned that lenders reject 90 percent of borrowers' requests to release their co-signers from the loan. Many lenders advertise this as an option, said the CFPB in a 2015 report.

Co-signers with good credit can help students get a lower interest rate on their private loans, because they agree to step in if the student can’t repay the loan. Co-signers weren’t regularly required on private student loans before the 2008 financial crisis, but by 2011, more than 90 percent of private student loans required a co-signer.

“Students often rely on parents or grandparents to co-sign 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 a 2014 report.

“Lenders should have clear and accessible processes in place to enable borrowers to release co-signers from loans. A borrower should not have to go through an obstacle course,” said Mr. Cordray, referring to some lenders' requirements that borrowers provide proof of graduation, college transcripts, employment or salary information, and even new credit checks.

As the Washington Post's Danielle Douglas-Gabriel explains:

A part of the problem is that private student loans are sold and bundled in with other loans, so while one lender may may not engage in auto defaults there is no guarantee that the next owner will do the same. What’s more, the contracts on those securities often come with restrictions that could make it difficult for the company servicing the loan to make adjustments for individual borrowers.

Though private student loans make up a small portion of the $1.2 trillion student-debt market, they are generally sought out by students with high levels of debt who also have federal loans, says the CFPB. These private loans tend to have higher interest rates and less flexible repayment options than federal loans.

And unlike other markets, points out the CFPB, there is no information on the size and performance of the private student loan market available to investors and to the public.

“Private student loan companies should own up to borrowers when they qualify for valuable benefits, clean up contracts with surprises buried in the fine print, and step up to provide borrowers and their co-signers the service they deserve,” said former CFPB student loan Ombudsman Rohit Chopra in a June report.

Critics, including Sen. Elizabeth Warren (D) of Massachusetts, argue that the student debt crisis places a "crushing burden" on young Americans and prevents them from making the type of investments in their future – such as buying cars, houses, and saving for retirement – that were available to older generations.

Student debt has emerged as a major topic in the presidential campaign. Most candidates have proposals to reign in the debt currently weighing down about 40 million Americans. These range from debt-free college to pairing students with private investors who would help finance their education.