The push to include student loan debt under bankruptcy protection

By William Pirraglia
Posted in: Student Loans, Personal Finance
The push to include student loan debt under bankruptcy protection

Shortly after buying that new, humongous high-def flat screen TV and state-of-the-art home theater system, you become downsized. You consider a Chapter 7 bankruptcy, but learn you can erase hat $10,000 home entertainment debt, but not $42,000 of student loans. What's wrong with this picture?

Student loans are not dischargeable in bankruptcy

The original logic was sound. Federal education loans are guaranteed by the U.S. government and, therefore, the taxpayers. In return for their guarantee, taxpayers deserve some extra protection against losing their hard-earned dollars. And the same protection is granted to private lenders.

The current discussion results from bankruptcy reform in 2005. Congress extended government lender protection to the private education loan sources. These lenders are for-profit corporations, earning higher interest rates while offering limited choices for restructuring student loan debt.

Unlike Federal student loans, which have a low (6.8 percent) maximum interest rate, private education lenders charge more, with rates of nine percent or more quite common. Federal Stafford (for students) and Perkins (for parents) loans offer numerous options to graduates to consolidate and repay loan balances. Private student loans offer a much more limited menu of repayment choices, although they do permit much larger loans than the federal variety.

This recipe for long-term problems is further "enhanced" by the borrower's inability to discharge these loans in bankruptcy. When you compare mortgage rates, do you immediately wonder what might happen in a bankruptcy? Probably not. Additionally, while you compare refinance rates to find the best offer, do most borrowers compare student loan rates with equal intensity? Most do not.

While auto loans and mortgage rates affect your repayment ability, student loans also influence your financial ability to repay. Over a four year college career, you could easily owe $40,000 to $100,000 - or more. Once in financial difficulty and considering bankruptcy, you must evaluate the net effect on your economic situation, after a discharge, to make the best choices.

The fairness debate continues

In early 2010, after the fiercest prolonged Congressional debate people can remember, new regulations almost pushed banks out of the education lending market. While this result was overshadowed by the passage of controversial health care reform, this action potentially removed billions of dollars from the education loan market.

It seems that, if one is a Democrat, the reasoning for this is sound. However, if one has more Republican tendencies, it appears that the premise for this action is ridiculous and simply an effort to "punish" banks for making money on education lending.

Through partners, like Sallie Mae and Nelnet, lenders received government subsidies to make student loans. Congress, with close votes in both House and Senate, believed that the government should no longer subsidize banks and private education lenders to make student loans and large profits.

Even one of the leaders in private student lending, Sallie Mae, tired of wearing a "target" on its back as the evil private lender, is supporting the premise that student loans should not be exempt from bankruptcy discharge. Both the Senate and the House are discussing bills to modify the current bankruptcy regulations.

While federal student loans would continue to be non-dischargeable, like overdue child support payments, IRS liens, and criminal fines, private lender education loans may soon be included in debts to be discharged. As you might imagine, there are vocal opponents to this change.

Opponents argue that:

Bankruptcies would increase.

Others disagree. Most people don't embrace bankruptcy as anything but a last resort. No one enjoys the process or the stigma of filing and completing a bankruptcy.

Banks would totally stop education lending.

Student loans are an unusual component of the lending industry. Most borrowers are, on paper, unqualified to obtain loans. Teenagers and young adults, without employment, who would waste time considering mortgage rates, are approved for thousands of dollars in student loans. However, others argue that recent banking industry reform regulations tightened up education loan credit, often requiring parent co-signers to receive student loans.

The cost to borrow would increase because of potential future losses.

Just as credit card companies justify high interest rates because of large losses, bill opponents argue that the same result would befall student lending if these loans could be discharged in bankruptcy. However, others state that no studies indicate that college graduates would simply file for bankruptcy to eliminate their student loans.

Other factors complicate matters

Another factor that complicates the issue surrounds the "different" nature of bankruptcy laws. Unlike laws that relate to murder, assault, and theft, which are inherently abhorrent, bankruptcy is really a "creature" of the government. Neither individual or company nor lender/creditor has done anything wrong.

Also, bankruptcy is federal legislation, but parts of the law can be modified by individual states. This quirk combined with the strong banking industry lobby always creates "spirited" debate in Congress. However, support is gaining for changing current bankruptcy laws to permit individuals to include private student loans in their list of debts to be discharged in bankruptcy.

Advice posted in: Student Loans, Personal Finance
Originally posted on: Dec 20, 2010

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