Acknowledging concerns by the public about the growing amount of student loan debt, the White House is urging Congress to reconsider the treatment of student loan debt in bankruptcy cases. To understand the importance of this push, it helps to address the history of student loan debt under the Bankruptcy Code.
Student loan debt was originally subject to discharge in a bankruptcy case like any other unsecured debt. Student loan lenders lobbied Congress to provide some protection for student loan debt in bankruptcy. Motivated by perceived abuses of bankruptcy by recently graduated students seeking to discharge their student loans – prior to embarking upon lucrative careers that would easily allow sufficient income to repay the loans – the Bankruptcy Code was amended to afford some protection to student loan lenders. Specifically, student loans could not be discharged unless they had been in a period of repayment (excluding deferments and forbearances) for over 7 years. The seven year time limitation was eliminated in 1994, meaning that student loans could not be discharged regardless of the amount of time that had elapsed since payments began. However, a debtor could discharge a student loan upon a showing of undue hardship. Unfortunately, meeting that burden was very difficult for even the most distressed debtors. Student loan lenders argued that this protection was necessary to allow continued lending with affordable terms to college students.[i]
In 2005, Congress broadened the protection of student loans, expanding the term to include any loan for an educational purpose. The protection from discharge applied equally to private and government loans. However, the Consumer Financial Protection Bureau has found that this additional protection from discharge did not manifest itself in more favorable terms for student loan borrowers, as loan rates remained the same in the years following 2005. Many institutes of higher learning were complicit in the propaganda, as they relied heavily on the student loan pipeline to fund their operations. Students and parents were poorly-advised about their repayment responsibilities.[ii] Now the perfect storm has emerged, where college graduates are emerging into a market with few opportunities, while heavily burdened with student loan debt. In addition, there are many people who were able to manage their student loan obligations, but have since lost their jobs. Or even worse, there are consumers who lost their jobs, and acquired student loan debt in the process of retraining for another career. Finally, and most problematic, are the individuals with student loan debt who have not completed their education. Consequently, they are encumbered with debt but lack the degree or training to find employment that will allow for the repayment of the debt.
In our practice, we see some type of educational loan debt in one out of every three bankruptcy cases. While most student loan lenders are generous with deferments and forbearances in the event of economic hardship, those reprieves come with a price as interest continues to capitalize on the student loans. While this article is not intended in any way to diminish the value of a higher education[iii], it is clear that some changes are necessary to protect consumers in the event of economic catastrophe. Some proposed changes to the bankruptcy law governing student loans would be as follows:
1) Allow cosigners who do not receive the benefit of the education, such as parents, to discharge their obligations without a showing of undue hardship. If the reason for the initial protection was for lenders to prevent the discharge of debts by the beneficiaries of the education – such as future doctors and lawyers – then parents should be able to discharge their liability. This assumes that the student loan cosigners are otherwise eligible to file bankruptcy.
2) Require transparency from Financial Aid offices, both in the disclosure of loan terms and liabilities to student loan recipients, as well as disclosure of financial information to federal authorities. Restrict the amount of student loan that the federal government will guarantee a particular school, if the average amount of student loan debt exceeds a certain portion of the established annual tuition rate.
3) Reinstitute a time period for the discharge of student loans owed for attendance at non-profit institutions, to allow for the discharge of loans that have been in repayment for a period of 7 years, provided that continuous payments had been made for at least 4 years of that 7 year period.
4) Allow for the discharge of student loans owed for attendance at for-profit institutions after the expiration of 5 years if the debtor received a degree, subject to payments having been made for at least 2 years of the time period. If the debtor did not receive a degree from the sponsoring institution, then they would be eligible to discharge the student loans after the expiration of 3 years, without any history of making payments.[iv]
5) Allow for the discharge of student loan debt at any time, without the elapse of a specified time period, in the event that the debtor has suffered a long-term hardship that would make payment of the student loans burdensome.
It is possible that implementation of such changes may curtail student loan lending to some degree. However, it is hopeful that secondary education institutions would adjust their costs to reflect that lower amount of money available to students, allowing for a reduction in tuition and other attendant costs of higher education. But there is no question that allowing some relief to overburdened student loan debtors will result in more money being put into the general economy for goods and services. Lending will always involve risk, and for too long student loans have benefitted from the generous treatment afforded to them under the Bankruptcy Code, all but eliminating any risk of repayment, other than through attrition. Even with the proposed revisions allowing discharge of student loans, they will still be better sheltered from the risk of bankruptcy that other lenders – such as credit card companies – have to face.
[i] This same argument was used by the mortgage lending industry, to prohibit modifications of residential mortgage loans in bankruptcy; as well as the auto lending and credit card industries in the lead-up to the 2005 Bankruptcy Reform Act. You be the judge as to whether you benefitted from more affordable financing terms in the years subsequent to 2005 from these lenders.
[ii] The expansion of protection for student loans meant that cosigning parents were subject to the same prohibitions against discharge as their children, even though the parents derived no educational benefit.
[iii] The author acknowledges that he would not be where he is today without the education that he received from Furman University and Wake Forest University School of Law. Of course, no price can be put on the importance of education that was taught to me by my parents.
[iv] See http://www.washingtonpost.com/local/education/report-finds-for-profit-colleges-serve-shareholders-over-students/2012/07/29/gJQA3zm6IX_print.html regarding the disparity of graduation rates among for-profit institutions.