What Borrowers Think They Know
Feedback from private student loan borrowers reveals they hold a host of common misconceptions about their loans. In comments and complaints submitted to the Consumer Financial Protection Bureau (CFPB), borrowers demonstrate a lack of knowledge about the difference between private and federal student loans, how bankruptcy can impact their loans, who holds and services their loans, what repayment options they have, and more. The consequences of these misunderstandings include unexpected default, forbearance fees, and ineligibility for repayment incentives.
It can be tough for colleges to identify and counsel borrowers of private student loans. Schools aren’t required to certify these loans, so students can borrow them without the school knowing. Most lenders voluntarily require school certification to help in identifying and counseling these students. As Pace Bradshaw, vice president for congressional affairs at the Consumer Bankers Association (membership includes banks that make private student loans), notes, “borrowers of school-certified loans are unlikely to over-borrow and more likely to be informed consumers.”
Sen. Richard Durbin (D-Ill.) has introduced legislation that aims to address this issue by requiring all private student loans to be school-certified.
NASFAA has been an outspoken advocate for Durbin’s Know Before You Owe Act.
When counseling is provided, does that information stick? “It’s hard to pound something into someone’s head unless you have that really in-depth discussion with them, which is probably logistically impossible for students who [take out private loans],” says Tom Sakos, director of student lending for DeVry University and a member of NASFAA’s new Task Force on Student Loan Indebtedness.
Here are five common myths revealed by the “Annual Report of the CFPB Student Loan Ombudsman."
Bankruptcy-related private loan issues were fairly common in the CFPB report. Three in 10 students reporting complaints about the servicing of their private loans said the issue was related to bankruptcy, default, and debt collection.
As the report shows, many students don’t understand the terms of bankruptcy and how it can affect their private loan. Unlike other consumer debt, student loans can only be discharged through bankruptcy if the borrower can demonstrate the debt will “impose an undue hardship” on them and their dependents.
That is difficult to prove. The U.S. Department of Education, CFPB, and higher ed associations, including NASFAA, have advocated Congress to amend bankruptcy law to allow private student loans to be discharged in bankruptcy.
Another issue the CFPB report highlights is unintended consequences of bankruptcy on student loan debt. One borrower restructured his nonstudent loan debt through bankruptcy to help repay his private loan. That loan was put into default even though it wasn’t part of the bankruptcy arrangement.
The CFPB report also highlights a case where a borrower’s cosigner declared bankruptcy without the borrower knowing. The borrower’s loan was placed in default, the borrower stopped receiving billing statements, and it negatively impacted the borrower’s credit.
As more private loan providers require a cosigner, it’s increasingly important for borrowers to understand how this impacts the terms of the loan. In 2007, only 60 percent of private student loans required a cosigner. Nine in 10 private loans required a cosigner in 2011, according to the CFPB.
2. Unexpected Banking Transactions
Students who borrowed money from institutions where they hold savings and checking accounts reported being surprised when the lender withdrew funds from one of those accounts when the borrower was late on a monthly loan payment. This often resulted in overdraft fees since the amount withdrawn by the lending company exceeded what the borrower had in checking. That circumstance highlights the need for borrowers to know how their banks handle late payments, a challenge even for those who are financially savvy. “I would argue that you and I don’t understand what provisions are in our checking and savings account,” Sakos says. “It’s very complex stuff.”
3. Where the Money Goes
Private loan borrowers also tend to have a poor understanding about how overpayments are applied to various loan accounts, the report contends. Borrowers with multiple private loans from the same lender were surprised to learn how payments that eclipsed the minimum amount were allocated.
Excess funds submitted to one loan payment were sometimes transferred to pay the minimum of the other loan instead of paying down the principle, despite the borrower’s intent. In other examples, excess monthly payments were automatically transferred to loans with the lowest interest rates rather than the loan with a higher rate.
Tim Fitzgiven, vice president of debt management services for National Council of Higher Education Resources, says private lenders’ payment application policies are outlined in the loan’s promissory note. Borrowers sending a larger-than-normal payment, Fitzgiven explains, should contact the lender and request specific application of that money and check their monthly statements to confirm overpayments were applied to the correct loan accounts. “I think it’s a prudent step for anyone who wants control of their own finances,” he says. “An informed customer is a better customer.”
4. Untapped Incentives
Some private lenders provide repayment incentives like interest rate or principal reductions for engaging in activities that increase the likelihood of repayment, such as graduation or enrollment in an auto-debit program. But students need to understand the fine print to capitalize on these incentives. One student quoted in the CFPB report said her enrollment in a lender’s automatic debit program did not go through because her application to the program was submitted too early. Borrowers have also become ineligible for benefits because they didn’t know it would take several days to process a payment.
The CFPB report includes a borrower who made 36 consecutive on-time payments, asked for her cosigner to be released from the private loan, and was denied because several payments—to her surprise—were counted as late due to the payment processing delay.
5. Limited Repayment Options
One of the most common concerns communicated by borrowers to the CFPB is the lack of repayment options. Unlike federal loans, most private loans don’t offer repayment options like the Income-Based Repayment program for borrowers who face unemployment, underemployment, or financial hardship. In addition, some borrowers made partial payments when they couldn’t afford the full payment, and were subsequently surprised to learn that these partial payments didn’t prevent them from defaulting.
“Up front, all that the borrowers are interested in is getting the funds, and they sometimes don’t pay attention to the wording of the agreements, which is obviously a big mistake,” Sakos says. “There are a lot of easily ignored rules in the borrowing process, especially with private loans.”