Many private student loan contracts have a tiny little clause, hidden away in the obscure depths of the fine print. It’s written in formal and somewhat vague language, but it basically says that if the cosigner or the borrower dies or declares bankruptcy, the entire balance of the private student loan is due immediately. This can be true even where the borrower (or cosigner) has been making regular, on-time monthly installment payments and can continue to do so.

I call this the “death and bankruptcy clause.” It’s essentially an automatic default: if you can’t pay the entire loan balance right then, the “accelerated” loan will go into default and collections. Sometimes, borrowers are not even notified of the situation until the loan has been placed with a third-party debt collector and has been reported to national credit bureaus as charged-off or defaulted.

As you can imagine, this leads to terrible situations. Imagine a borrower who has a good job and is making regular payments, when the cosigner (perhaps a well-meaning family member who got into trouble, or an ex-spouse who the borrower hasn’t heard from in years) declares bankruptcy. Suddenly, the student loan is in default. Or how about the situation where the borrower’s mother dies – mom is a cosigner on the borrower’s private student loan, and hasn’t really had much to do with the loan since she originally signed for it. But now, the borrower is going to have to deal with default and a collections agency, on top of the grief of losing a parent.

Absurd, isn’t it?

Well, this little clause from hell might be getting extinguished.
According to The Washington Post and Consumerist, the Consumer Financial Protection Bureau (CFPB) is going to start bringing legal actions against student loan companies that place borrowers in automatic default following the death or bankruptcy of a cosigner. The CFPB will argue that these practices are unfair and deceptive, as many borrowers are not made aware of this provision, and the language is often quite broad and ambiguous.

To my knowledge, no legal action has been initiated by the CFPB as of yet. However, in my own student loan law practice, I have seen a noticeable drop in lender enforcement of these provisions. I think it is likely the result of bad press and increasing scrutiny from state and federal regulatory bodies, including the CFPB.

If the CFPB takes strong legal action and prevails, it might be the death of the “death and bankruptcy” clause.