Congress Rethinking Student Loans in Bankruptcy

This week, a key House of Representatives subcommittee begins to re-evaluate how bankruptcy law treats private student loan debt.

This another part of Washington’s current push to alter bankruptcy laws yet again, however this time the results may benefit of the average person.

Inside Higher Ed reports that Rep. Steve Cohen (D-Tenn.), the chair of the House Judiciary Subcommittee on Commercial and Administrative Law, has held a hearing to begin crafting legislation that will undo a 2005 change to federal bankruptcy law.

The law in question,he says gives private student loan lenders a “favorable and unusual” advantage over student borrowers and their parents, as well as more preferential treatment compared to the issuers of most other kinds of consumer loans.

Cohen is determined to take action on the issue in the near future. “Hopefully it’ll be bipartisan,” he says of the proposed legislation. “And if not, you know, we’ll just have to forge ahead and do what’s right.”

The ranking Republican on the subcommittee, Rep. Trent Franks, (R-Ariz.) has not closed the door on GOP support. Still, he says that any bill ending the favorable treatment private lenders receive would likely be the death knell of the private student loan industry, the entirely of the job falling to government lenders, an unacceptable solution in the eyes of many Republicans.

Currently, bankruptcy law prevents nearly all borrowers from getting rid of their private student loan debt when filing bankruptcy. Most other forms of debt – from home loans to utility bills – can be discharged when filing chapter 7 or chapter 13 bankruptcy. The only exceptions to the student loan rule are made in cases of “undue hardship.”

Lauren Asher, president of the Institute for College Access and Success, says that federal loans can’t be discharged either, but that type of loan comes with a fixed interest rates, flexible payment plans and other consumer protections.

“Private student loans are one of the riskiest ways to pay for college,” she says. Such loans are “not financial aid any more than using a credit card to pay for tuition or books is financial aid.”

The issue of private loans is becoming more pressing as more and more students use them to cover the gap between federal aid and college tuition, a gap as wide as $12,500 per year on average in some studies.

Two thirds of all graduates of four-year colleges have student loans and a third of students took out private loans, according to Asher’s ICAS studies. The percentage of students taking out private loans in any given year has risen 10% since 2003-2004.

Financial institutions oppose any changes, in particular a return to the status quo of 1975, when debtors could still discharge student loans via bankruptcy within five years of graduating.

That system, warns J. Douglas Cuthbertson, an attorney who represents some lenders, led to “debtors filing for bankruptcy almost solely on student loans.” Congress barred student loans’ discharge within five years, then barred discharge in seven years, and, in the most recent and onerous change, made it almost impossible to discharge student debt at any point.

Brett Weiss, a consumer bankruptcy attorney who testified before Cohen’s subcommittee says such a return to bad old days is unlikely. Even in the 1970s, he says, a study commissioned by the government found that less than 1% of all matured student loans had been discharged in bankruptcy.

“The notion of people who view bankruptcy as an easy debt-elimination option is so far from the reality, it’s just absolutely dead wrong,” Weiss says. “Student loans are not the primary factors for bankruptcy filings. They are sort of in the mix. People very, very rarely file for bankruptcy because of a student loan.”

One compromise approach: Changing the definition of an “undue hardship,” which would allow bankruptcy courts wider latitude in making faster decisions regarding whether a debtor should have his student loans discharged. A Congressionally-mandated definition could make it much easier for debtors to receive an “undue hardship” exception without a long and complicated legal process.

Both Democrats and Republicans have indicated that they are willing to explore this option. Once the exploration begins, however, bipartisanship may yet creep in again, with overstretched Americans still waiting for unbiased debt relief choices.