Top 5 Reasons that Student Loans should be Dischargeable in Bankruptcy

what obama should do for student loan debt relief

President Obama’s executive order with regard to student loan debt relief doesn’t go far enough. Here are five reasons why the President and the Congress should go further:

1. Even the IRS Doesn’t Get the Protection that the Student Loan Creditors Enjoy.

When most people think of a creditor that is going to get its money, they think of the IRS. However, current law allows bankruptcy discharge of certain tax debts more than three years old if tax returns were filed a couple of years before the bankruptcy filing. It’s a little more complicated than just that, but the point is that if the IRS and state tax agencies have to take a bath sometimes in bankruptcy, why not student loan creditors?

2. Lenders Would be Discouraged from Lending Students So Much Money.

Talk about a dream customer for a lender: someone between the ages of 18 – 21 who is about to get an education that is expected to help that person earn $500,000 more, over a lifetime. Now throw in the fact that this person will probably never be able to get rid of the debt in a bankruptcy. Is the “availability” of this money related to tuition’s rise at double & triple the rate of inflation for the last 25-30 years? In a society where we finance that which we cannot afford, people will pay if they can borrow. Look at the housing market.

3. Lenders Would be Motivated to Make Deals with Student Loan Borrowers.

Right now, there is almost no motivation for a student loan creditor to make a deal with a borrower. Without bankruptcy as an option for most borrowers, the student loan creditor is encouraged to jack up bogus fees, accumulating interest and collecting portions of the debt when they can. In addition, consumer protection in general is conspicuously absent for student loan borrowers. There is no Statute of Limitations for student loan debt (not including private loans). Even the IRS doesn’t try to go after tax debt that is more than ten years old!

4. The Reason for Bankruptcy not being available for Student Loans, which Started in 1978, was Wrong from the Beginning.

The banksters got Congress to create the student loan exception to bankruptcy discharge by creating a scare campaign that students would go get college degrees and then immediately turn around and file bankruptcy to avoid paying for college. Former Rep. James O’Hara, who fought against the student loan exception to discharge, stated that the idea that students would abuse the system “existed primarily in the imagination.” Fraud is possible in any credit transaction, but students are the only borrowers automatically presumed to be cheats and thieves.

The truth is that when the bankruptcy discharge was available for federally funded student loan debt in the 1960s and early 1970s, there were a few abusive situations but it happened less than 1% of the time.

Even after the bar on the bankruptcy discharge was implemented in 1978, it was only a temporary waiting period: a student could not discharge student loan debt for five years after the beginning of the repayment period on the loan. In 1990 the waiting period was increased to seven years, and only in 1998 did it become a permanent bar.

In 2005, Congress included private student loans to the exception to bankruptcy discharge, giving privately funded loans the same protection previously reserved for loans funded or guaranteed by the federal government. There was very little (if any) public debate on this; however, the number of private student loans taken out by undergraduates has been in the rise since 2003, and is projected to go up in the future.

5. Boost Our Economy by Getting Certain Borrowers Out of a Virtual Debtor’s Prison.

People eligible for bankruptcy relief will not able to spend money on local goods & services if they will be paying student loans the rest of their post-bankruptcy life. Restoring the bankruptcy option to student loan debt is not as drastic as the controversial proposal to simply forgive all student loan debt in the U.S.; we are only talking about people who are able to get bankruptcy relief under a Fresh Start (Chapter 7) Bankruptcy, or an Individual Repayment Plan (Chapter 13), in which the borrower is eligible pay back part of the debts, according to the borrower’s income, over a period of 3 – 5 years.

Conclusion

This proposal simply seeks to treat student loan debt like any other debt, or at least put student loan creditors in the same position as the IRS. (See ten-year rule referenced above).

An obvious compromise would be to bring back the waiting period after the start of the repayment of the loan, such as existed for the 20-year period between 1978 and 1998.

Other fixes to be considered would be to bring back some basic consumer protections when it comes to student loan lenders, and to create a statute of limitations so that student loans cannot be purchased by debt buyers and revived as zombie debt for the rest of a person’s natural life.

But to have student loan debt in its current immortal, untouchable form is intolerable.

9 Responses to Top 5 Reasons that Student Loans should be Dischargeable in Bankruptcy
  1. John Westover
    October 28, 2011 | 4:50 pm

    Excellent article, Jim. It’s high time that this debate got underway. You hit the nail on the head; student loans are unsecured debts, and it is financial folly to loan so much money so freely to our young people. In my estimation, this wide-ranging debt load will have staggering consequences in the ongoing economic crisis.

  2. Steven Steinbach
    October 31, 2011 | 11:53 am

    Excellent article! This is the real solution for those who find themselves saddled with long term, increasing student loan debt. Our political leaders need to have more backbone and stop letting the banks influence such Draconian policies.

  3. Armando Baralt
    November 4, 2011 | 7:26 am

    Excellent article. This is a message that has to get out. Can I please repost with attribution on my web site? All bankruptcy attorneys need to spread the word on this. Also, this really needs to get out to the mass media – somehow!Maybe NACBA can help?

    • James Michel, Debt Relief Attorney
      November 4, 2011 | 9:56 am

      Thank you, Armando, and yes, please repost to your site with links to my sites SanFranBKBlog.com and JamesMichel.com.

      About whether NACBA can help, good question! This is already the position of both NACBA and NACA.

      I was inspired to write this article following the news of Pres. Obama’s 10/26 speech which was being touted as “Student Loan Debt Relief” but were really just slight adjustments to the IBR & ICR Plans that have been around for a few years.

  4. Arthur Blutter
    November 7, 2011 | 8:42 am

    There are substantial arguments in my opinion to not allow student loans to be dischargeable.

    1. There seems to be a conspiracy , real or imagined between the entitled student generation and the entitled educational institutions. Both do not consider the five per or six percent increase in costs. And once the wonderful federal government guarantees these amounts, no one is motivated to put a stop to the exploitation among and between the entitled classes. And, of course, the ultimate sucker becomes the government.

    We have too many in the entitled class, and they should use market influences to limit the great increases in the misuse of entitlement spending.

    Education is one of the many areas that is being exploited. Among the other areas that are being exploited are health, defense, retirement benefits, agriculature, foreign countries, etc. The list just never ends.

    And I am not saying this for political reasons either!

    • James Michel, Debt Relief Attorney
      November 7, 2011 | 9:15 am

      Dear Arthur,

      Thanks for your comments! You bring up the issue of an entitled class. The focus of my article is positing that the entitled class is the banks! The banks, and the US Department of Education, are making a profit off of student loans in default. It doesn’t seem to me that you have addressed the issue of why should student loans be any different from the other debts which are subject to a bankruptcy discharge. I do not see evidence for the conspiracy that you suggest. I do agree about areas being exploited.

    • Jenna Palmer
      November 7, 2011 | 12:13 pm

      The “entitled student generation”? The truly entitled don’t need to borrow money to go to college. Students and their parents have been told for years, whether true or not, that the only way to succeed in life is to have a college degree, so no wonder they are scared into borrowing more for it than they can afford, especially when they’re convinced that wonderful jobs are waiting for them on the other side. Maybe there is a conspiracy, but it would be between the banks, who are making a ton of money off student loans, and the colleges, who can charge more and more for a degree only because the banks are willing to lend it. For-profit colleges are particularly predatory in their recruitment of new students, despite their often low graduation rates, and to get them to take out private loans whose interest rates and collection techniques are equally predatory.

      If the government is concerned about the taxpayer they should stop guaranteeing these private loans. But the fact is the government is not losing money on these loans, and wasn’t even before the new law protecting the banks was passed.

  5. Jason Paskowitz
    December 18, 2011 | 8:31 pm

    It’s clear that the exploding amount of student loan debt (now eclipsing even credit card debt in the US) is a problem that will have to be dealt with. Comments like Mr. Blutter’s are indicative of the anti-education, rabble-rousing sentiment that the student debt industry, and their corrupt buddies in the Department of Education/FSA/DCS have been using for years. I.E. ‘Those uppity college kids with their spring break trips and sports cars.’ Of course, the reality is more like my own college experience — going home during school breaks on a Greyhound bus.

    In any event, perhaps the best argument for REAL student debt relief (not just the lukewarm IBR/ICR programs) is that it will have an IMMEDIATE stimulative effect on the economy. One trillion dollars divided by an average house price of $250k = 4 million houses that could be purchased. Hence, an immediate solution to the real estate crisis. The economic multiplier effect of this would be in the several trillions of dollars.

    It is time to stop pandering to the well-financed, rent-seeking student debt industry and their cronies at the ED, the equally-guilty parties in academe itself, and the various self-serving mouthpiece organizations like NASFAA and NCHELP.

    Jason Paskowitz
    New Jersey State Lead
    StudentLoanJustice.org

  6. Alan Collinge
    December 19, 2011 | 5:35 am

    The poster above claims that there are significant arguments for the removal of bankruptcy protections for student loans, but then launches into a confusing mix of conspiracy talk and assorted jargon.

    What are these significant arguments, sir? You said they exist, so where are they? If all you have is what is above, then I think we’re done here.

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