House Subcommittee Weighs Discharging Private Student Loans in Bankruptcy

Congressman John Conyers, Jr., D-MI, put it this way:

Your yacht is dischargeable in bankruptcy, your vacation place is dischargeable in bankruptcy, your second or third homes are all dischargeable in bankruptcy… then you run into these people trying to get an education who go to a bankruptcy judge and no, the door is closed.

And Representative Conyers is correct. Unlike a mortgage, an automobile loan or credit card debt, student loan debt can’t be erased by declaring bankruptcy — or at least not without exceptional circumstances and without a fight.

But a House subcommittee held a hearing today to discuss why, how and if that should change.

Student loans haven’t always stuck to debtors, even those in bankruptcy, like glue. Prior to 1976, student loans were dischargeable like most other consumer debt, but that changed when the U.S. Bankruptcy Code was amended to place limitations on which loans could be erased.

The thinking was that Congress didn’t want to undermine the federal student loan program, with all its protections, lower interest rates and benefits for borrowers, by allowing students to take out massive loans they had no intention to pay. But over time, this exception has evolved to include private student loans, which have none of the borrower protection provisions that make federal student loans so attractive.

Today, Subcommittee Chairman Representative Steve Cohen, D-TN, said it happened “without any rationale for such expansion.”

And some of the experts who testified before the panel today agreed.

Lauren Asher, the president of The Institute for College Access and Success, explained that unlike federal loans, private loans, which were taken out by a third of students in college last year at some point during their education, often lack a fixed interest rate. She went as far as saying that:

Private loans are not financial aid any more than using a credit card to pay for tuition.

[Which got me thinking -- at the time I began graduate school, I had enough credit on various cards that I could have financed a year of my education. If I declared bankruptcy, that could be discharged. My loan from Citibank will follow me to the grave.]

Another expert, law professor Rafael Pardo, pointed out the magnitude to which some former student borrowers in debt — according to his research, student loan debtors are in more distress than those declaring bankruptcy and the average borrower is someone in their 40s who would need to set aside two years and nine months of their pretax income in order to pay off their student debt. “This is a crushing debt burden, plain and simple,” Pardo said.

Pardo’s written testimony pointed out that:

The median debtor in the Discharge Litigation Study would have had to devote two years and nine months of household income to fully repay his or her student loans. In comparison, consider that the median debtor in the general bankruptcy population in 2007 would have had to devote approximately one year and three months of income to fully repay his or her total unsecured debt.

One panelist, J. Douglas Cuthbertson of Miles & Stockbridge in Virginia, pointed out that changing the bankruptcy code could have some negative effects. If students were permitted to file bankruptcy immediately following graduation, Cuthbertson argued that private lenders would no longer offer private loans, which often fill the gap between what students can borrow from federal loan programs and the cost of tuition.

New Congressionally mandated disclosure requirements on private lenders take effect next year, but student advocates at the hearing argued that the law did not go far enough to protect students from taking on unmanageable amounts of ballooning debt.

Pardo argued that to truly modify the bankruptcy code to level the playing field between student borrowers and private lenders, Congress would have to remove the restriction on discharging private loans in bankruptcy and clarify the legal definition of undo hardship, which determines under what circumstances a loan can be discharged, because it is applied inconsistently