Originally featured on CUToday.
CARMEL, Ind.—The resumption of payments on federal student loans is going to lead to two issues credit unions are going to need to confront: more auto loans headed for default and, for many borrowers, issues that have already led to litigation related to reimbursements not being paid, Allied Solutions is cautioning.
Specifically with the latter, the company said borrowers are not being refunded for the ancillary products they purchased, such as gap, which were not fully used because their loan term ended prematurely.
That scenario has led to class-lawsuits and growing regulator attention, explained Peter Krall, VP-national markets/sales specialist, risk and recovery, at Allied Solutions.
“At Allied we do have growing concerns that more borrowers will default due to student loan repayments beginning again,” Krall said. “My opinion is the lenders are taking it more on the chin than the other parties in this food chain. Specifically, when a financial institution acquires the retail installment sales contract, meaning from a dealer, they become the holder of that agreement. They're servicing that auto loan and they're servicing the products within that auto loan that the dealer sold in their F&I office. Things like gap, vehicle service contracts…”
Considerations Needed
When anything causes that retail installment sales contract to terminate early—such as a repossession, an early loan payoff, a trade-in or total loss—considerations need to be made by the lender on how to cancel and or refund those optional ancillary products sold by the dealer’s F&I office, Krall said.
“The regulators continue to find that often those products are not in fact being cancelled, and they continue to bring this up in their routine exams, specific consent orders, or matters requiring attention,” Krall said. “They're saying, “Look, even though the consumer knows they may be entitled to a refund, they're not getting them’.”
Krall pointed out the only party that can state the debt obligation has been properly completed is the lender.
An ‘Easy Target’
“And the lenders seem to be that easy target for the regulators to go after here,” Krall said. “I would say, based on the current regulatory environment, the credit union needs to take a good look at this process. When they purchase that retail installment sales contract, it really is at that point in time, when you fund the loan, the credit union needs to know what they are purchasing from that dealer in order to service not only just the auto loan but in some cases the liability that they take on when it comes to the refundability of these products.”
The refunds are often in the $400-$600 range, Krall said. “Which is why regulators won’t let this go,” he said. “Regulators are scrutinizing financing practices, leading to significant penalties, including a Consumer Financial Protection Bureau directive for some lenders to pay up to $3.7 billion for various violations, emphasizing the need for transparent and compliant refund processes.” Much of the controversy, according to Krall, centers on lenders' handling of gap refunds, with some claiming refunds are only provided in states where legally mandated.
“The CFPB, in theory, could contest this, citing location-based discrimination,” Krall said. “The CFPB’s enforcement expansion of Anti-Discrimination through UDAAP alone should serve as a major red flag to lenders. Add to that a surge in state laws, accountability settlements, and a heightened focus on overcharging and refund miscalculations all signify a broader issue—an evident gap in understanding and a means to comply.”
‘Time to Innovate’
Krall explained that the CFPB's consistent efforts to target what it says are unfair practices highlight the importance for lenders to examine their refund processes and ensure a compliant process, particularly as more states contemplate gap refund legislation.
“If a lending institution hasn’t done so already, it’s time to innovate with integrity,” he said. “For example, when a borrower pays off their loan early. Doing the right thing, the credit union should at minimum let the borrower know they may be entitled to these optional product refunds, and to consult with their dealership regarding the sale of these products. And then go to the administrators of those products that the dealership sold you—the gap administrator, for example.”
‘Increased Scrutiny’
Krall noted that, unfortunately, even when a lender simply notifies a borrower a refund may be due, “the regulators continue to find that the consumers aren't getting their refunds for a myriad of reasons, and that's what's led to a lot of class-action suits going back to 2020 and a lot of increased scrutiny from state regulators, NCUA, the OCC and certainly the CFPB.”