Will Private Student Loans Be Dischargeable in Bankruptcy?

by Gary on February 20, 2013

Bankruptcy was originally designed to give the consumer a fresh start by discharging debts and easing the stress of unpayable monthly obligations. Some debts, however, are have become more difficult to discharge with each new iteration of the bankruptcy system. When student loans first came into wide use, they were dischargeable regardless of their age or their originator. Congress then limited discharge to five year old loans backed by governmental agencies or issued by non-profits, which was later stretched to seven years, and eventually were made nondischargeable unless the court — via adversary proceeding — made a finding of of “undue hardship”. Finally, in 2005, Congress made private student loans also nondischargeable absent a finding of “undue hardship.” Much has been made of this fact considering that student loan debt has risen at an incredible clip in recent decades, now topping more than $1 trillion.

Considering that so many young and old are burdened with crushing student loan debt, efforts are underway to tackle the problem. One option would change the law to ease up on the restrictions that prevent the educational debt from being discharged via bankruptcy.

Congressional Proposal

In late January 2013, several U.S. Senators introduced two bills that relate to the student loan process– the Fairness for Struggling Students Act of 2013 and the Know Before You Owe Act of 2013. The latter expands disclosures so that borrowers and their parents will maximize less expensive government loans and other financial aid resources before resorting to high interest private loans.

The Fairness act would allow borrowers to discharge privatestudent loans in bankruptcy. This option has been discussed in the past, and it gained a bit more traction last year when the Consumer Financial Protection Bureau and the Department of Education both endorsed the idea of rolling back BAPCPA to allow debtors to discharge private loans.

Importantly, this bill would apply only to loans from private lenders, like Wells Fargo, Chase, and the like. It would not apply to funds borrowed from the federal government. Private student loans represent roughly 20% of the total student loan burden (about $150 billion). However, these private loans usually come with far higher interest rates and higher fees.

Those supporting the measure argue that the features of these loans make them much more of a private profit center, and resemble credit cards more than student aid. Many feel that labeling these as education loans is an insufficient reason to continue treating the loans as something more than ordinary unsecured signature debt, which is ordinarily dischargeable in bankruptcy.

In a press release announcing the re-introduction of the bill, one of the chief sponsors argued, “It’s not only young people facing this crisis, it is parents, siblings and even grandparents who co-signed private loans long ago and are still making payments decades later. It’s time for action. We can no longer sit by while this student debt bomb keeps ticking.”

Difficult Road to Passage

In reality, that this legislation faces significant opposition. These measures were introduced in the last Congress with little support (both bills died in committee). Much opposition comes from those lenders who might stand to lose money if students are able to discharge the loans in bankruptcy. Others argue that going forward would make private student loans even more expensive in the future, limiting students’ access to funds. They note that some lenders are already getting out of the business.

No matter what happens to these proposals, an experienced student loan attorney can review the status of your student loans in light of your personal circumstances, to determine the courses of action open to you. This may be especially important if you have had a life-altering event that could qualify you for a hardship discharge. At other times, bankruptcy may be prudent to resolve other debt, easing the burden even if student loan obligations remain.

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