President Obama got people thinking when he raised the possibility of discharging certain education loans in bankruptcy within the context of the executive action he signed last week — the one that's intended to ensure unfettered access to government-sponsored relief programs and a means for registering complaints about unfair treatment.
Not to be outdone, 13 U.S. Senators introduced the Fairness for Struggling Students Act of 2015 just two days later. Their bill proposes to place private student loans on equal, bankruptcy-eligible footing with other consumer debts; in particular, those that are similarly uncollateralized.
The problem is, none of this will mean very much.
Private student loans represent roughly 10% of all student debt, and less than 10% of those loans are actually in default. So even if every defaulting borrower were to end up in bankruptcy court, neither measure would address more than 1% of the whole.
So why not acknowledge the obvious and dispense with the artificial distinction between federal and private student loans in this matter?
Because bankruptcy is a four-letter word in our culture. To most, it represents abject failure—the white flag of surrender. To others, it's tantamount to amnesty — a deceitful ploy to avoid having to pay for a mistake.
Yet why do we seem to be able to rationalize the discharge of mortgage, auto and credit card debts more than for education loans? Is it because many of us have managed to meet our own obligations? Or could it have something to do with the way we've learned to regard this category of debt?
The exclusion of student loans from bankruptcy dates to the mid-1970s when – following years of disparaging stories about students who were allegedly "defaulting on purpose" as a passive-aggressive means of expressing their anti-government sentiments – generational gap-driven emotions trumped reason and 11 USC 523(a)(8) came into effect.
Having taken out my first student loans around that time, I recall the stories and the strong reactions they elicited—both on and off-campus, as my friends and I worried the program would be discontinued. But I also remember that those same inflammatory news reports were later discredited. Unfortunately, the damage was already done. The notion of "elitist," "ungrateful" young borrowers became a part of the narrative, inspiring additional restrictions in subsequent years that culminated in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 — legislation that granted the same exception to private student loans. (A good chronology of the various legislative actions can be found here.)
To be fair, though, it's not as if education-loan borrowers didn't get anything out of the deal. After all, it costs a lot more to carry a credit card balance despite the fact that both types of debt are equally unsecured. The $1.2 trillion question, however, is this: Does a lower interest rate justify the student-loan borrower's demotion to second-class citizenship?
Consider what would happen if the bankruptcy exception were repealed.
Lenders would be motivated to negotiate sustainable, longer-term accommodations with borrowers who are on the brink because, as the saying goes, "A rolling loan gathers no loss." So, too, would the schools come under pressure to reduce tuition rates because reasonably priced financing will become that much harder to attain.
Still, the idea of making education-related debts eligible for discharge is worrisome, given the potential impact on our taxpayer-supported system of finance. All the more reason to act now to head off that risk.
It doesn't take a whole lot of lending experience to realize that when roughly half of all the loans in your portfolio require some form of accommodation to facilitate repayment, it's obvious the remittance schedules were improperly designed at the outset.
These loans – all of them – need to be restructured for terms of up to 20 years without consideration for the entity that originated the contract (public versus private sector), payment status (current, past-due or in default), or subjecting borrowers to annual re-qualification. (I read that 40% of income-based repayment participants fail to file the necessary forms on time.) Debtors should also have the right to accelerate repayment without penalty so they may save on interest.
Not only should we do this now, but we can well afford it, too.
There is more than enough spread between what the government pays for the money it borrows to fund these loans and the interest rates and fees it charges to students and parents. Couple that with tighter controls over the loan servicing and debt collection processes and bankruptcy will once again be viewed the way it was originally intended: as a last resort.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
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