Private Student Loans—A Helpful Guide
Private Student Loans—A Helpful Guide
The Federal regulators issued Guidance on Private Student Loans with Graduated Repayment Terms at Origination, in 2015 to outline principles financial institutions should take with respect to originating private student loans that have graduated repayment terms. Typically, loans with graduated repayment terms provide the borrower lower initial monthly payments that gradually increase over the life of the loan. Most student loan agreements include a grace period to help students transition between the period in school and post-education. Adherence to these principles could benefit both the institution and borrowers alike.
The guidance is cognizant to the reality that students leaving higher education programs may prefer more flexibility due to current labor market factors. These labor market factors include:
- Competitive job markets
- Low entry level salaries
- Higher student debt loads
Aligning borrowers’ income levels with loan repayment requirements may provide flexibility to repay the debt sooner if borrowers’ incomes increase more quickly than projected. This arrangement may increase the likelihood of full repayment.
Graduated repayment terms are available under some federal student loan programs. The regulators noted that the credit risk associated with federal student loans differs from that of private student loans, so therefore, some of the repayment features offered under the federal loan programs may not be suitable for private student loans.
As with other products originated by financial institutions, private student loans with graduated repayment terms should be underwritten so they are consistent with safe and sound lending practices, and provide necessary disclosures that clearly communicate the timing and the amount of payments to help a borrower understand the loan’s terms and features.
Principles for Private Student Loans with Graduated Repayment Terms at Origination
- Ensure orderly repayment: Repayment terms should avoid negative amortization or balloon payments. Loans should have defined repayment period that are orderly over the life of the loan. Graduated terms should ensure timely loan repayment and be adjusted according to reasonable industry and market standards based on debt outstanding.
- Avoid payment shock: Payment shock happens when a borrower experiences a significant increase in the amount of monthly payment after a reset date. Terms should be structured in a way that result in monthly payments that a borrower can meet in a consistent manner over the life of the loan. Incremental increases in monthly payments should begin early in the repayment period and phase in the amortization of principal to limit payment shock.
- Align payment terms with a borrower’s income: Graduated terms should not be structured in a way that could mask delinquencies or defer losses. Terms should be based on reasonable assumptions about the ability to repay. An assessment of borrower’s ability to repay the highest amortizing payment over the term of the loan should be carried out by the lender.
- Provide borrowers with clear disclosures: Disclosures should clearly communicate the timing and the amount of payments to help borrowers understand their loan terms and features. In addition, disclosures should be in compliance with applicable laws and regulations. For example, the Truth in Lending Act, as implemented by Regulation Z includes specific private student loan disclosure language requirements.
- Comply with all applicable federal and state consumer laws and regulations and reporting standards: Loan Terms must comply with all applicable consumer protection laws. These include, but not limited to, the Electronic Fund Transfer Act, ECOA, federal and state prohibitions against UDAAP, the Truth in Lending Act, and the regulations related to those laws.
- Contact borrower before reset dates: Financial institutions should develop processes for contacting borrowers before the start of the repayment period and before each payment reset date. These types of contacts can help make student debt repayment a payment priority with borrowers and potentially cause borrowers to respond positively to payment increases.
Adherence to these principles surrounding private student loan could benefit both the financial institution and their borrowers alike.