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Proposed Bill Would Change Role of Student Loans in Bankruptcy

Student loans have become infamous for rarely being discharged in bankruptcy. However, before 2005, only government-backed student loans were protected—private student loans could be forgiven in bankruptcy.

The Chicago Defender reported that several U.S. lawmakers have proposed a piece of legislation that would allow bankruptcy courts to once again discharge student loans issued by private lenders.

The legislation, which is still in its earliest stages, would address what its sponsors (including Rep. Danny K. Davis, Sen. Sheldon Whitehouse, Sen. Dick Durbin, Rep. Steve Cohen and Sen. Al Franken) see as an unrealistic burden of debt many students have upon graduation.

Indeed, the statistics cited by the Defender and a press release from Senator Durbin’s office are eye opening:

• Until the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) took effect in 2005, private student loans were treated like other loans in bankruptcy; now, they can only be discharged if a filer can show "undue hardship."
• Congress recently ended a $6 billion subsidy to private student lenders, thus eliminating one advantage they had over other lenders. This student lending reform was signed into law as part of the health care reform legislation. The sponsoring legislators argue that the restoration of dischargeability will further level the playing fields.
• Private student loans have increased in both popularity and cost in recent years, some coming with interest rates at and above 15 percent.

If the new bill becomes law, its sponsors contend, it will give students wishing to pursue higher education a certain peace of mind, as they will have the option of discharging the associated debts should they encounter unexpected financial hardship.

The Current Law

As it stands now, BAPCPA permits individuals who file for Chapter 7 bankruptcy protection to receive a full discharge of many unsecured debts (that is, filers are excused from paying these debts); however, some debts cannot be discharged in a Chapter 7 filing. These include:

• Spousal support (alimony)
• Child support
• Student loans
• Most tax debt

Supporters of the new bill apparently believe that student loans don't fall under the same category as the other non-dischargeable debts, as they do not contribute directly to someone's wellbeing.

But the bill will likely have obstacles to overcome in Congress. Opponents are likely to point out that making private student loans dischargeable in bankruptcy decreases lenders' security when issuing these loans and could lead to increased interest rates and fees to compensate for potential lost income.

Additional Resources

Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) (PDF)

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Handling Student Loans Outside of Bankruptcy

As a recent article from the Wall Street Journal highlights, student loan debt is a huge burden for many Americans. But, unlike credit card debts, student loans cannot typically be discharged in a bankruptcy filing.

And now, as layoffs and salary reductions become more and more common around the country, many once-comfortable graduates are finding themselves unable to meet the terms of their loans. Here are some ways you can handle your student debt.

Know Your Numbers

If you need to rework the terms of your student loans, consider contacting your lender. But before you do so, take these preparatory steps:

• Outline your budget: Crunch the numbers and figure out what you can realistically afford to pay each month.
• Read the fine print: Make sure you understand the terms of your loans as they now stand so that you’ll be ready to ask for specific modifications when you speak with your lender.

Once you’ve determined what kinds of payments you can make, familiarize yourself with your options for repayment. Depending on your circumstances, these may include the following:

• Modify your repayment plan: Some lenders offer graduated repayment schedules, meaning you pay more per month as you go along (which can be useful if you expect to make more money in the future). If your loans are through the Federal Government, visit the Federal Direct Loan web site to see your choices.
• Consider a deferment: Many lenders offer you a chance to defer payments for a variety of reasons (such as going back to school, working in certain fields, being unemployed, etc.). Check with your lender to see how to apply, but keep in mind that interest will likely still accrue during the deferral period.
• Apply for forbearance: You may also be able to make reduced payments or suspend payments altogether for reasons of financial hardship but, as with deferments, interest will likely still build up.
• Look at consolidation: Consolidation offers often prove helpful because they allow you to make a single payment each month and can even help lower interest rates. But be sure you understand the complete terms—some come with prepayment penalties.

If you’re just beginning school and considering loan options, remember that they may not seem like a big burden at this stage, but can add up quickly and should be considered carefully.

Additional Resources

Federal Student Loans: Learn the Basics and Manage Your Debt (PDF)

Posted in Setting the Record Straight about Bankruptcy, Student Loans, student aide, student loan bankruptcy | Comments Off