Thursday, September 20, 2007

Why Private Student Loans Should be Dischargeable in Bankruptcy

Private student loans are unsecured consumer debt. Both unsecured consumer debt, such as credit cards, and secured debt such as auto loans and mortgages, are dischargeable in Chapter 7 bankruptcy. The only financial obligations that are not dischargeable in bankruptcy are things like court-allocated fines and child support, as well as federal student loans. At first blush, it would seem that the burden of proof is on those who say that student loans should be treated differently from all other forms of debt.

The adverse consequence arising from the current situation is that simply by virtue of being enrolled in an institution of higher education, including cosmetology school, people are able to borrow $50, $100, or $200,000 in unsecured loans, completely without regard to their ability to repay. If their income after leaving their programs falls short of the amount required to repay the loans, they then have absolutely no recourse.
These people are just like people who have taken out subprime mortgages, except the bank can't take the house back. There is no house.
Student Loan Justice has many tales of people who have committed suicide or fled the country after reaching this dead end. Or they may just abandon their aspirations, and/or live in poverty.

The adverse consequence, some argue, in making private student loans dischargeable in bankruptcy is that banks would become more cautious about their risk. The loans would become more expensive, and banks may try to determine if someone will be able to pay back the loan, based on their course of study or other factors.

Should lenders in general become more cautious about the risk of loans? YES.
Should they try to determine if the loans they make will be affordable to borrowers? YES.
This is what correction in the credit market looks like. Turning off the faucet of easy credit
may be painful but is necessary for mortgage lenders, credit card marketers, and all other types of debt.
If this necessary correction results in adverse social consequences, rather than continue the ability of banks to make money risk-free off the backs of students, maybe we need to think about shrinking the role of the private sector in higher education finance, and strengthening the commitment of state and federal governments to ensure higher education access. This means increasing financial aid, providing low-cost loans at the government's rate of capital, protecting borrowers, and controlling tuition increases. Unaffordable private debt does not equal higher education aid.

28 comments:

Adam said...

You're forgeting one very important thing... one main reason that student loans are unable to be discharged is that banks have to have an incentive to loan an 18 year old money to go to school with no credit history upon which to base a decision.

Like I said before, I'm ok with no private student loans. I'm not ok with taking up the slack with increased government spending (higher taxes) which will never operate outside of the red.

Just running some basic numbers in my head... the new subsidised rates will not even cover overhead (debt servicing usually costs 1.5 - 2% per annum, plust capital and origination costs that are probably another 4.5%) much less keep up with inflation over a 30 year period.

If my tax dollars are going to go towards setting up a federal student loan system it's going to have to be as efficient as the private sector and should not LOOSE money every year. We've got a large enough budget deficit and I'm not convinced that the increased tax revenues liberals like to claim from federally subsidised education are anywhere close to the expenses incurred.

Anonymous said...

I have a question for you....how do you suggest people pay for college? Unlike the other industries you have compared student loans to, such as mortgages and credit card debt, a college degree is a proven asset. For every single case that Alan over at student loan justice tries to sell you about someone who killed themself over a student loan debt, there are a thousand stories of people who have improved their life by dedicating themself to going to school, studying hard, graduating, getting a good job, and paying back their loans.
I absolutely agree that something should be done. I am all for a more cautious approach, but not at the expense of those people who desperately want a better life but don't have great credit. Giving people the option to file bankruptcy only gives them an easy out. Why not focus on making the collection of loans not such an aggressive action? Why not give people a chance to make good on their debt?
The fact of the matter is, college is expensive, loans are necessary, you are better off with a college degree then not, and regardless of what happens, it is the responsibility of the individual taking out the loan to make sound decisions. Just my opinion.
A few supporting pieces:
http://studentloanwatcher.com/another-new-york-times-student-debt-sob-story.htm
http://www.businessandmedia.org/articles/2007/20070613151631.aspx

Traciatim said...

I thought one of the main reasons that the student loans were changed to be non-forgivable in a bankruptcy was that many students would just go to school, get their degree, rack up credit card debt and then declare bankruptcy on leaving the school.

Since they will be around 24 and won't be buying a house for a few years, what do they have to lose? Now they have a degree, can land a descent job, start fresh with no debt and in 10 years have a nice investment income to pay for a house and start a family.

Where does that leave the honest people that actually pay their obligations?

In every scenario you will have a few who abuse the system, the vast majority that follow the rules that get by, and the few that slip through the cracks. No matter what the rules are in every scenario this will happen. I think what we have now is more than adequate.

Perhaps people that get poor grades, can't manage money, and can't handle the stess of a high paying job should be serving fries. Not everyone deserves to be the CEO of a company when they grow up.

Anonymous said...

Well said Traciatim. I agree 100%. As someone who has honored my obligation to pay back student loans, which has not been easy, I think it is a valuable lesson and one which will certainly serve graduates well.
Great points and a refreshing change from the Alan Collinge types out there who are obviously only covering the fact that they made poor choices and couldn't pay back their debt.

adam said...

traciatim, I agree with you but unfortunately personal responsibility and accountability are soooo out of style.

Screw all the hand-holding, government regulation, leftist, populist dogma. Vote Libertarian.

Imagine that... someone having to EARN something for a change.

Anya said...

for readers' information:
Businessandmedia.org is a corporate lobbyist misinformation shill website.
http://studentloanwatcher.com/ has more interesting and reputable information on it, but I bet based on the tone it is also maintained by someone in the private student loan business.
This leads me to believe that some of these commenters are connected to the loan industry and not just speaking from their personal experience and beliefs.

Dr. D - mypiratecaptain@gmail.com said...

I will happily speak from my own experiences and beliefs. In the interest of disclosure, I work in higher education administration, not connected to financial aid.

The reason the laws disallow bankruptcy filing to eradicate student debt was as Adam indicated. The Baby Boomers went through school, sometimes grad, law, and medical school, came out, declared bankruptcy, and went about their lives. They worked the system.

Then when I was in school (late '80s, Gen-X), there was little money to be had. I could only borrow $5000 for the whole degree -- a tiny percentage of my private education. Thanks to my parents and working many jobs, I got through.

I then paid cash for my masters and doctorate by working full time and going to school at night. It was difficult, but possible. And more of these online, weekend, and evening programs are becoming available every day.

Not everyone can or should go off to school at 18. Young people need to earn their way in the world. I know plenty who have made their way through school on GI Bills or by working. Maybe it was slow going, or a less than picturesque collegiate experience, but they did it.

This generation has the option for private loans and government support. There is no justification for them then turning around after their education is complete and discharging those loans. The outlier cases of people taking their own lives due to debt are more indicative of that individual's mental health than a faulty system.

I am now dealing with my Gen-Y sweetheart's $90k in student loans. It places a huge burden on us as a family. It limits our quality of life, our ability to buy a home, and our ability to save for retirement.

But that's life.

We borrowed it and we owe it back. End of story.

No 18 year old fully understands the ongoing burden of the debt they agree to when signing loan papers. They overestimate their earning potential and what the $500+ payments per month for decades will mean to their quality of life.

If anything, student loans should be more difficult to secure so young adults consider more fully what their options are and whether they are college material. For many, that will mean delaying their education or going into a trade. But that's a good thing.

I don't think we need more young people with six figure debt and degrees in poetry and massage therapy. If they know that money will have to be paid back, come hell or high water, at least a few will consider their path more carefully and either earn more profitable degrees (i.e., engineering) or consider career paths that do nor require degrees (i.e., plumber).

In the past 20 years, we've hit the extremes of no money being available, and now, too much money being available. Let's swing back to center, offering reasonable amounts at appropriate lending rates and accept that not everyone is meant to earn a degree by borrowing their way through. A degree earned through hard work will evoke better choices and end this trend of young adults hiding out in school for years with no goals and minimal earning potential.

D said...

Just a huge correction to a previous comment. The Business & Media Institute, www.businessandmedia.org, is a media watchdog group that has a mission of "advancing the culture of free enterprise in America." Our mission is to make sure the media accurately and fairly report the major issues involving business, the economy and the free enterprise system.

I will gladly match journalism credentials with Anya any day.

Dan Gainor

Anonymous said...

as a student loan borrower myself i cannot agree.... i was totally taken advantage of by one school and was charged ridiculous amounts and everyday the interest rises and i never worked in the field that i had went to school 9 months for and never received "the riches" i was sold when signing up. so they should be deemed forgivable in certain circumstances, so that you cant have them written off and make money in what you actually went to school for.... lets say i went to school to be a dr and then when i get out say filing bankruptcy then a yr later i am a dr that a big no-no if this was ti happen then thats when the gov't steps in and makes you repay what they have forgiven and make it a # of yrs after you graduate like 20 after you file bankruptcy you cant work in that field you went to school for... i believe this will help

Anonymous said...

I really don't think you've thought through the implications of making these loans dischargeable in bankruptcy.
I know you're sincere in your interest in improving the situations for students but is something that would hurt all parties.
People need to pay back their loans. It hurts the loan industry if they don't recuperate cost and consequently the costs are passed onto to more responsible lenders.

I must also add that from personal experience people ought not spend money they don't have. I fit the stereotype of the cheap asian - I literally spent a quarter of the amount of money that most of my friends paid. Where as I sacrafice - rarely went to movies, cooked my own meals, used public computers, biked to class, didn't buy expensive toys like xbox's, etc - my friends didn't and they should suffer the consequences. Before attacking the loan industry which isn't forcing people to take their loans (yes they are providing us with a service; take it or leave it), you should be bashing students.

The general mistake you're making and you've constantly made in your analysis (and it's one that many people do in economics) is that you're focusing in one specific group of people and you're not thinking long term.

And no I'm not a shill for the banks and I find it a bit weak that you would suggest that of some of the commentors here instead of addressing their points.

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Alan Collinge said...

Most of the people on this blog--in particular those who are bashing StudentLoanJustice.Org, and me, its founder:

1. Make their living from student loans

2. Are engaged in a clear campaign to discredit student borrowers who have been abused by a predatory student loan system astonishingly absent of consumer protections.


I could easily respond to all the stock- and fallacious- arguments they present, but I have already done so on any number of blogs on the net.

I invite all curious readers to come to StudentLoanJustice.Org, consider the facts presented there, read borrowers stories from real citizens, and decide for yourself whether the student loan industry has become a predatory system or not.

Alan Collinge said...

Clearly, most of the people here bashing StudentLoanJustice.Org, its members, and its founder (me) work for the student loan industry.

They present ridiculous arguments that have nothing to do with the real issues involved with student loans. They paint the borrowers, particularly defaulted borrowers, as a drain on the taxpayer when in fact the opposite is true: The Federal government gets back all principle, and an additinal 20% in interest and fees from defaulted loan debt.

These people are engaged in a longterm, and apparently well funded campaign to discredit the StudentLoanJustice movements, and ensure that the astonishing lack of standards consumer protections for student loans persists.

I invite all interested readers to come to StudentLoanJustice.Org, read the facts presented on the website, and stories submitted from real citizens (without an agenda) and judge for yourself whether this system is predatory or not.

Anonymous said...

Something needs to happen with the private student loan industry. I have a loan that went from $350 to $630 in a 6 month period. This is a huge increase, especially when you have small children. I have been paying on it for 4 years. This year I paid around 7300, and my 1098E shows that 6600 was to just interest. They will not work with me on my payment. They said I am not allowed to defer or ask for a forbearance. I have done everything in my power to keep up with this payment, but I can't live on $400 a month (after paying my bills) with the price of gas and two children in diapers (and one of them is on formula). I don't get government help...if that is what you are thinking in your heads.

Anonymous said...

For what its worth...

I was mislead by the school that I attended into takeing Private Loans. I borrowed something close to 12,000. I have not missed one payment and I know owe 45,000 4 years later. My payments have gone up to almost $700.00 dollars a month and my intrest rate just keeps going up. There is no way that I will be to pay this amount each month and still have money left to live. What am I supposed to do?

berto xxx said...

Private student loans are unsecured consumer debt. Both unsecured consumer debt, such as credit cards, and secured debt such as auto loans and mortgages, are dischargeable in Chapter 7 bankruptcy. The only financial obligations that are not dischargeable in bankruptcy are things like court-allocated fines and child support, as well as federal student loans. At first blush, it would seem that the burden of proof is on those who say that student loans should be treated differently from all other forms of debt.

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Anonymous said...

I went to truck driving school and they were unable to get me a job after graduating. It wasn't considered a student loan. I'm not positive though. Why should I have to pay it back when the school couldn't provide in their guarantee of a position? And yes it was a guarantee!

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pharmacy said...

Eduacation, it's not everything how we can educate our children if we don't even know what's gonna happen in 60 years from now on... ?? ??? ? ??

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This is what improvement in the credit marketplace looks like. Turning off the faucet of easy credit may be hurting but is necessary for advance lenders