The Department of Education and the Consumer Financial Protection Bureau have asked Congress to consider allowing students to discharge their private student loans through bankruptcy. Most students have not been able to discharge these loans since the Bankruptcy Code was amended in the early 2000s.
Before the amendment, former students were able to discharge student loans through bankruptcy after waiting five years. The Dept. of Ed and the CFPB would like to return to the old way of doing things, allowing students to discharge private loans after a period of repayment.
Some of the reasons that the agencies gave for their request include:
- Private student lender underwriting standards have lessened. Private lenders reduced school involvement in the lending process, allowed students to borrow more than financially necessary and originated loans to students with lower credit scores.
- Borrowers may not have exhausted their federal student loan limits because they did not understand the repayment options of private student loans.
- Ten percent of recent four-year college graduates face monthly student loan payments that are greater than 25 percent of their income.
- Default rates on private student loans have risen dramatically since 2008.
- Private student loans are credit-based and similar to other credit-based loans that are dischargeable in bankruptcy.
- There is no evidence of systematic abuse of the bankruptcy code regarding student loan discharges.
- There is no significant evidence that the 2005 bankruptcy code changes caused access to credit to increase or prices to decline.
According to the CFPB, "We heard from many distressed student loan borrowers facing trouble making payments on private student loans due to limited options for alternate payment options. Consumers, as well as businesses, have been able to restructure other types of debts through bankruptcy as a last resort. But with less guaranteed flexibility compared to federal loans and very limited bankruptcy options compared to other consumer loans, private student loan borrowers facing tough economic times may be challenged to emerge as productive contributors to our society."
For now, former students cannot discharge their private student loans through bankruptcy. However, as more federal agencies push to make the change back to allowing these discharges, we may in fact see positive change occur for students suffering from overwhelming debt.
Source: Consumer Financial Protection Bureau, "Private Student Loans," July 20, 2012.