On January 29, five federal regulatory agencies (Consumer Financial Protection Bureau, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and National Credit Union Administration) issued new guidance regarding private student loans with graduated repayment plans that allow borrowers to make lower monthly payments early in the loan term with increases to coincide with projected income growth.

The guidance is intended for financial institutions that originate private student loans that provide graduated repayment terms at origination. It advises such institutions to “prudently underwrite the loans in a manner consistent with safe and sound lending practices” and to “provide disclosures that clearly communicate the timing and the amount of payments to facilitate a borrower’s understanding of the loan’s terms and features.” To that end, the guidance suggests that financial institutions consider the following principles in underwriting private student loans with graduated repayment terms:

• Ensure orderly repayment. Private student loans should have defined repayment periods and encourage repayment throughout the life of the loan. Graduated repayment terms should conform to reasonable market standards based on the outstanding debt. Lenders should avoid negative amortization or balloon payments.
• Avoid payment shock. Loan repayment terms should include monthly payments that are realistic for the borrower. Graduated increases in monthly payments should begin early and phase in the amortization of the principal balance to mitigate “payment shock” for the borrower.
• Align payment terms with a borrower’s income. Graduated repayment terms should be based upon reasonable assumptions about the ability to repay. Lender underwriting should include an assessment of a borrower’s and a cosigner’s ability to repay the highest payment over the term of the loan. The terms should be transparent and avoid deferring losses.
• Provide borrowers with clear disclosures. Financial institutions should provide borrowers disclosures in compliance with applicable laws and regulations. Disclosures that clearly convey the timing and amount of payments facilitate borrowers’ understanding of the terms and features of their loans.
• Comply with all applicable federal and state consumer laws and regulations and reporting standards. Private student loans with graduated repayment terms must also meet all relevant consumer protection laws (e.g., the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Truth in Lending Act) and all regulations relating to those laws.
• Contact borrowers before reset dates. The guidance also states that financial institutions should develop processes for contacting borrowers before the repayment period begins as well as prior to each payment reset date. Timely contact promotes the prioritization of student loan debt and assists borrowers in being prepared for payment increases or other issues.