Private student lenders use a web of hidden, complex policies that most borrowers are unaware can lock them into a scenario that could wreck their finances.
The Consumer Financial Protection Bureau reported last Thursday that 90% of people who tried to get a co-signer off their student loan were rejected. The data came from the CFPB's database of more than 3,000 consumer complaints. The vast majority of people who take out loans from private lenders to pay for college have someone co-sign their loan. A co-signer — often a parent — agrees to take responsibility for debt that a primary borrower doesn't pay back.
The inability to ditch a co-signer can be a huge problem, the CFPB said, because having two people on a private student loan can lead to disastrous consequences for both of them.
People use co-signers because it can initially lower their interest rate on loans, or qualify them for loans that they wouldn't be able to access otherwise. Lenders like co-signers because having them on board makes it less risky to lend to an 18-year-old who wants to study basket-weaving. Those two sets of interest explain why 90% of private student loans were co-signed in 2011, according to the CFPB.
When its time to pay the loan back, though, private lenders often start doing strange things, without much warning. There are clauses that let lenders put borrowers in default — a standing that adds penalties and can crush credit scores — for not telling a lender that their address changed, for example. When that happens, the co-signer becomes liable for the entire loan.
On the other hand, when a co-signer dies or goes bankrupt, many lenders demand that the former student immediately repay the entire balance of the loan. The CFPB exposed that practice in a report last year. It said this year that lenders are still at it.
It isn't hard to imagine why people would want out of this particular bind. But when borrowers asked to take full responsibility for the loan, the answer was almost always negative, the CFPB said. Such requests were sometimes rejected for absurd reasons, such as having made too many early payments. The lender penalized them for not making consistent payments, even if no additional payments were due. They were also rejected for not having good enough credit, even though lenders often did not tell borrowers what threshold they needed to meet.
The CFPB has urged lenders to be clear as to when borrowers might be doing things that could make it harder to let their co-signers off the hook. For now, though, anyone considering taking out a private loan with a friend or relative is looking at taking on a very long-term relationship.