How to Avoid Auto Defaulting on Your Student Loans

There are two certainties in life: death and taxes. If you’ve just finished your dealings with the second, you might find yourself wishing for the first. If a group of major lenders like Sallie Mae have their way, though, there may be a third: student loan repayment.

A report by the Consumer Financial Protection Board details a loss-prevention tactic called automatic default. As a result of this tactic, even good-paying borrowers suddenly find themselves in default when a co-signer on the loan (usually a parent or grandparent) dies or declares bankruptcy.

It’s a pretty big deal because up 90 percent of indebted students have an adult cosigner on their student loans. The responsibility and credit-worthiness of their adult co-signer ensures the young lender can get a reasonable rate and lending institutions get the added guarantee that a responsible adult will cover the loan if the student can’t. And because of the automatic default provision described above, if one of the parties that’s responsible for the loan can’t pay it back, the loan is due, in whole, immediately.

Some lenders are willing to work with students to find more humane repayment strategies. However, to begin this process, they often will want a significant payment up front. For most students who are fresh out of college, coming up with that money is a virtual impossibility.

Private lenders say the practice is necessary to protect their interests against a rise in student loan default. They see the death or insolvency of a responsible party as increasing the risk that the loan won’t be repaid. They need the protection of auto-default to avoid losing money. Student loans are also bundled and traded as securities, which may oblige lenders to start the process.

Critics assert that these auto-default practices are unfair. Young people must deal with a tremendous financial burden besides the stress of losing a parent. A loan in default also puts a black mark on a student’s credit history, making it difficult for them to get a house, a car, or even a job.

It’s important to note that these clauses are only found in private student loans. Federal loans, like Stafford or the PLUS program, do not have auto-default clauses. According to the Consumer Financial Protection Board (CFPB), about 90 percent of private loans do.

The consumer protection board is considering lawsuits and regulation to combat this practice. In the meantime, let’s take a look at what consumers can do to protect themselves.

Review Your Loan
Go over your loan documentation for these “auto-default” clauses. In some of the most tragic cases, the news of a default can blindside students. And if you are still in college, you’re likely at the greatest risk.

Without another adult cosigner, you may be unable to complete school while also being burdened with repayment demands. Talk with your co-signer about who else will be able to cosign your loans in the event something happens to them.

Be Smart About Your Loan Choice
Where possible, try to avoid using cosigned, unsecured loans. This includes things like credit cards, student loans, and small business loans.

The benefits of lower interest rates may not outweigh the risk to your credit. It may be easier to finance your education with a secured loan, like a mortgage.

Get in Front of the Problem
If you’ve graduated, speak to your lender about releasing your co-signer from the loan. It’s likely that you’re a better credit risk as a college graduate with a little bit more work and credit history. Most lenders are willing to do this only if you’ve paid your loan on time each month.

So make sure the last 6 months of payments have arrived on time. Also, make sure any other errors on your credit history are erased, and that you’re as low a credit risk as possible. Then, call your lender and speak to a human. Explain the situation, and ask for your co-signer to be released from the loan.

Consider a Consolidation Loan
If all else fails, consider a consolidation loan. While this may have a higher interest rate than the student loan, you can avoid the potential dangers of auto-default. These may also be a good choice if you have considerable credit card, car, or other high-interest debt.

Getting one payment can put you on the path to financial independence and help you avoid the worry of auto-default if something should happen to your co-signer.

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