On January 29, the federal financial regulatory agencies, in partnership with the State Liaison Committee of the Federal Financial Institutions Examination Council, issued guidance for financial institutions on private student loans with graduated repayment terms at origination. This guidance provides principles that financial institutions should consider in their policies and procedures for originating private student loans with graduated repayment terms. The principles, in brief, enunciated in the release issued by the Federal Deposit Insurance Corporation, are as follows:
- Ensure orderly repayment. Private student loans should have defined repayment periods and promote orderly repayment over the life of the loans. Graduated repayment terms should ensure timely loan repayment and be appropriately calibrated according to reasonable industry and market standards based on the amount of debt outstanding. Graduated repayment terms should avoid negative amortization or balloon payments.
- Avoid payment shock. Graduated repayment terms should result in monthly payments that a borrower can meet in a sustained manner over the life of the loan. Graduated increases in a borrower’s monthly payment should begin early in the repayment period and phase in the amortization of the principal balance to limit payment shock to the borrower.
- Align payment terms with the borrower’s income. Graduated repayment terms should be based on reasonable assumptions about the ability to repay of the borrower and cosigner, if any. Lender underwriting should include an assessment of a borrower’s (and, if applicable, a cosigner’s) ability to repay the highest amortizing payment over the term of the loan.
- Provide borrowers with clear disclosures. Financial institutions that offer private student loans with graduated repayment terms should provide borrowers with disclosures in compliance with all applicable laws and regulations.
- Comply with all applicable federal and state consumer laws and regulations and reporting standards. Private student loans with graduated repayment terms must comply with all applicable consumer protection laws. These include, but are not limited to, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, federal and state prohibitions against unfair, deceptive, or abusive acts or practices, and the Truth in Lending Act.
- Contact borrowers before reset dates. Before originating private student loans with graduated repayment terms, financial institutions should develop processes for contacting borrowers before the start of the repayment period and before each payment reset date.
The guidance has been criticized by industry representatives as both overly restrictive and opaque. Some representatives questioned the notion of gauging the ability of an 18-year-old college freshman to repay.
Read the press release here.