Do We Need to Change Bankruptcy Rules for Student Loans?

This is the fourth article in a series devoted to consumer issues for National Consumer Protection Week March 3-8.

Ever since the Guaranteed Student Loan Program was established under the Higher Education Act of 1965 — offering government-guaranteed loans to students — an ongoing debate has ensued over whether a student loan borrower should have the same option of discharging the debt in bankruptcy as consumers facing default on other types of debt.

The most recent re-igniting of this debate arose this past January when Sen. Dick Durbin introduced the Fairness for Struggling Students Act of 2013 (S. 3219), that would mark a return to the pre-2005 days when private student loans could be discharged through bankruptcy like any other form of private debt.

With this being National Consumer Protection Week, and the Consumer Financial Protection Bureau issuing a call for private student loan borrowers to share their stories this week, what better time to take a fresh look at student loans — both private and federal — and seriously question whether student loan debt should be categorized the same way that delinquent child support, back taxes, and DUI-related personal liability debt are as a kind of debt that cannot be discharged in bankruptcy. Of all forms of consumer debt, only student loan debt is treated in this way.

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First, let’s take a look at a very brief timeline of student loan history:

• 1965: Higher Education Act establishes the Guaranteed Student Loan Program.
• 1976: Higher Education Act amended. In response to claims of over-use of bankruptcy to discharge government loans, this law prohibited federal student loans from being discharged in bankruptcy until five years had passed since repayment began, and in cases of undue hardship.
• 1998: Tax Bill established. After extending the five-year wait to a seven-year wait in 1990, this requirement became infinite — virtually eliminating discharge in all but the most undue of hardships — for discharging a federal student loan in bankruptcy.
• 2005: Bankruptcy Abuse Prevention and Consumer Protection Act passes. Private student loans joined federal loans as being non-dischargeable in bankruptcy.

And here’s some background on private and federal student loans:

• Private student loans tend to be the loan of choice for students after reaching the maximum loan amounts for federal loans, and for those attending for-profit colleges.
• 46% of for-profit college students carry private student loans vs. 14% of public college students.
• Federal student loans make up 80% and private student loans the other 20% of all outstanding student loans.

Finally, let’s illustrate the magnitude of student loan debt:

• In June 2010, the amount of student loan debt reached $830 billion, exceeding the amount of U.S. credit card debt for the first time ever, and it grew to more than $1 trillion by October 2011.
• At more than $27,000, the average graduate’s student loan debt has more than doubled between 2005 and 2012.
• $8 billion worth of private student loans were in some stage of default by the end of 2012.

While this student loan debt problem took decades of complexities to get to the crisis proportions seen today, three trends are clear in terms of how we got to where student loan debt has surpassed credit card and all other types of debt:

1.     The cost of a college education has skyrocketed.
2.     Employment opportunities for graduates have dwindled.
3.     Wages have remained stagnant.

Add to this the inability for a low-or-no-wage college graduates to ever get out from under the mounds of student loan debt, and you not only have a catastrophe waiting to happen, but one involving trillions of dollars and millions of citizens whose only crime was trying to pay for an education.

While concerns of abuse, fraud, and accountability are often raised as reasons to continue disallowing this form of financial relief, there is no reason to believe the provisions in existing bankruptcy law can’t work to the degree that they prevent abuse of credit card, mortgage and other debt.

Possible solutions, such as an income-based approach, to this crisis will be discussed in future posts; however, for now an immediate step that can be taken in the right direction is by supporting the Fairness for Struggling Students Act of 2013.  While admittedly this bill only addresses 20% of student loan debt, it’s a start toward reversing an unfair law directed at one of the most economically vulnerable segments of the population who just happen to be our future.

This story is an Op/Ed contribution to Credit.com and does not represent the views of the company or its affiliates.

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Tagged as: bankruptcy, debt, ncpw, student, student loans

Barry Paperno As Credit.com's Credit Scoring Expert, Barry provides a perspective on credit and personal finance that comes from more than 25 years serving the credit industry, representing FICO, Experian, Bank of America, and others.