Legislation Would Allow Private Student Loans to be Discharged in Bankruptcy

Student loan debt and delinquencies have grown at such an alarming rate over the past couple of years that Sen. Dick Durbin, D-Ill., was prompted to introduce legislation in an effort to create significant change for millions of Americans. His goal through the Fairness for Struggling Students Act is to make it possible for a borrower in dire straits to eliminate education loan debt issued by private lenders through the bankruptcy process.

Currently, private student loan debt is grouped alongside overdue taxes, alimony, child-support debts and criminal fines — not available for dismissal through bankruptcy courts. The U.S. Bankruptcy Code at 11 USC 523(a)(8) provides an exception to bankruptcy discharge for education loans. The new legislation would put private student loans in the same category as credit card accounts and other unsecured debts.

Congress has prohibited student debt from being discharged through bankruptcy since 2005, except in rare circumstances. Bankruptcy, lawmakers theorized, was too tempting an option for young people who typically didn’t have any major assets to lose in the process.

Student Loan Debt Exceeds $1 Trillion

This debt elimination option, some lawmakers believe, may help relieve the current financial crisis situation many graduates face as they struggle to make monthly payments and fall into loan delinquency.

It has been reported that current outstanding student loan debt has exceeded $1 trillion this year, with more than $100 billion borrowed in 2010 alone. According to the College Board, the bulk of student loans are currently made by the federal government — accounting for more than 90 percent of all borrowing in the 2010-11 academic year. Non-federal loans, the ones affected by this particular proposed legislation, include those issued by states, banks and credit unions. Government-backed loans are not included in the legislation.

Economists don’t see the situation improving any time soon as a tight job market and a challenging economy have made it nearly impossible for a significant number of borrowers to reduce their overall debt load. As tuition and enrollment has climbed at colleges and universities, so has the need for students to borrow. At the same time, according to a study completed by Progressive Policy Institute, the average earnings of a full-time worker with only a bachelor’s degree ages 25 to 34 was reduced by 15 percent over the last decade. It is estimated that 27 percent of borrowers who have already begun student loan payments are considered delinquent, according to the Federal Reserve Bank of New York.

Those who favor the proposed bill believe the threat of bankruptcy would encourage lenders to negotiate terms with borrowers having serious trouble making payments. And with the increased cost of tuition combined with the caps on federal student loan lending, this would affect millions of students who must utilize both federal and private lending as they seek higher education.

Enticing Students, Discouraging Lenders

Not everyone favors the proposed bill, however, especially some banking-industry groups who say the ability to discharge debt through bankruptcy would only entice students to accumulate large amounts of debt knowing they possibly wouldn’t have to repay it.

Opponents of the bill also fear the ability for graduates to easily file bankruptcy on private loans will continue to discourage lenders from dealing with student loans altogether. According to FinAid.org, there are currently 22 lenders willing to provide student loans, down from approximately 60 before the market crash.

Other critics suggest such an act would cause lenders to charge higher student loan interest rates to make up for the increased risk of loss.