Bankruptcy Fight on Private Student Loans

Ed Policy - 

The U.S. House of Representatives has a chance today to provide much-needed relief to low-income and minority students who have fallen victim to predatory private student loan practices by Sallie Mae and other lenders.

House Members will vote on an amendment, sponsored by Rep. Danny Davis (D-IL), that would reverse a 2005 law making it virtually impossible for borrowers who are in financial distress to discharge private student loans in bankruptcy.

In the past, Higher Ed Watch has argued for this change. But as we learn more about how Sallie Mae "partnered" with giant publicly-traded, for-profit higher education companies to push high cost private loans, with interest rates and fees exceeding 20 percent, on high-risk borrowers with poor credit, we are even more convinced that Congress has a moral obligation to act.

For most unsecured debt, a borrower who runs into difficulty can file for Chapter 7 liquidation or Chapter 13 reorganization, so a judge can sort out the appropriate treatment of various loans. But there is a short list of debts that the law subjects to a different status, allowing discharge in only the most extreme circumstances. The government, for example, makes it especially difficult for people to escape child support responsibilities, overdue taxes, and criminal fines.

Federal student loans also can't be discharged. There's at least some justification for providing federal student loans that status since they are backed by taxpayer dollars and come with borrower protections in cases of economic hardship, unemployment, death and disability. But there is no good reason for private student loans to be accorded the harshest bankruptcy status given to criminal fines, child support, and back taxes.

To be clear, we're not advocating allowing borrowers to claim bankruptcy willy nilly in order to avoid student loan repayment. Our view is that private student loans should not be treated any differently than other forms of consumer debt when it comes to bankruptcy. Right now they are, and that's wrong. People who borrow private student loans are trying to better their lives. They should not be treated more harshly than those who rack up credit card debt at the mall.

Shielding private loans from bankruptcy in almost all circumstances means that repayment demands extend essentially forever, leaving even the most destitute borrowers with no way out. And bankruptcy exemption makes private student loan providers less cautious about peddling high cost loans to low-income students who might never to repay them. In other words, it promotes the kind of subprime lending that Sallie Mae was engaged in at some of the most scandal-ridden chains of for-profit colleges. Treating private student loans like other forms of unsecured debt would at least cause lenders to think twice before providing high-interest loans to people who they know will have trouble paying them back.

The Davis amendment takes a responsible approach to helping financially-distressed borrowers. Under the measure, private loans would not become dischargeable until five years after they come due. The five year wait protects lenders from a loan being discharged before a borrower has had an opportunity to reap financial benefits from his or her education.

In addition, after the five years, borrowers wishing to have their private loans erased would still have to meet a strict means test that Congress set up as part of the 2005 law to prevent consumers from abusing bankruptcy laws by trying to escape debt they can afford to repay.

Lender Opposition

Lenders were scrambling yesterday to kill Davis' amendment by spreading misinformation and fear. The loan provider MyRichUncle, for example, who we normally like, worked to get Blue Dog Democrats to sign on to a letter warning that the measure's passage would hurt low-income students.

"Many students would lose access to the funds they need to pay for higher education," the letter stated. "This would, in fact, disproportionately impact students from lower income families...Students whose parents do not have good credit simply would not get the loans they need."

Don't believe it. Private student loans were widely available before the 2005 bankruptcy law change and they will be after. Besides, low-income and high-risk students do not have to, and should not, rely on high cost private loans to go to college. Between federal student loans, which are universally available, and federal grant aid, over a thousand state and community colleges are within reach, including flagship state universities. And many private colleges have generous need-based institutional aid budgets that allow financially-needy students to enroll without taking on enormous debt.

Too many disadvantaged students have been hurt by predatory lenders and the subprime student loan mess. By passing this important amendment, the House can take an important step to ease their burden.