Bankruptcy

Where's the Bail Out for Borrowers?

Ed Policy — Thu, 17 Apr 2008 22:39:00 -0400

After Tuesday's surprisingly one-sided hearing before the Senate Banking Committee on the credit crunch, it's clear that Congress is prepared to take steps to add liquidity to the student loan marketplace. But as lawmakers move forward with plans to bailout student loan giants like Sallie Mae, they shouldn't forget about the financially-distressed borrowers who have been victimized by the lenders' predatory private loan practices. Surely, they deserve a helping hand too.

Over the last two years, we at Higher Ed Watch have written extensively about how loan companies' aggressive marketing practices and cozy relationships with colleges have pushed students to take on unnecessarily high levels of expensive private student-loan debt, often before they have exhausted their lower-cost federal loan eligibility. In fact, at least one in five private student loan borrowers take out a private loan before they exhaust safer, cheaper federal Stafford loan options.

Lenders will deny responsibility until they're blue in the face, but they're the ones who have been feverishly marketing $30,000, $40,000, or $50,000 a year direct-to-consumer private loans to undergraduates. In pop-up Internet advertisements, youtube videos, and television and radio commercials, the companies tout the convenience of applying for private loans but seem to brush by the fact private loans are more expensive than federal loans and lack important safeguards.

Lobbyists for colleges and financial aid administrators place the blame squarely on direct-to-consumer marketers. But many private colleges and high-priced public universities are also putting students in harm's way by including private loans in the financial aid packages they offer students. Packaging private loans gives students the misleading impression that they have no choice but to take out these loans. It also leaves them with the impression that these loans have the colleges' imprimatur and therefore must have pretty reasonable terms, which they seldom do. Worse, some lenders have encouraged colleges to brand the loans with their institutions' names -- which only adds to the confusion.

Perhaps the students who have been hurt the worst have been the low-income and working-class students who were pushed to take out subprime private loans, with rates and fees totaling more than 20 percent, to attend poor-performing trade schools owned by giant for-profit higher education chains like Career Education Corporation and Corinthian Colleges. By all accounts, defaults on these loans are growing alarmingly. And serious questions have been raised about whether these companies have duped disadvantaged students into taking on private loan debt without making them aware of their cheaper loan options first.

Now don't get us wrong. Congress is preparing to take steps that will make private loan borrowing somewhat safer for future students. Lawmakers are finalizing legislation to renew the Higher Education Act that would, for example, ban lenders from co-branding private loan products with a college’s name or logo. The legislation also includes provisions that aim to discourage lenders from making subprime private loans and that would make it easier for colleges to counsel students against taking on private loans prior to exhausting their federal student loan eligibility.

These provisions are all good, but they won't provide any relief to borrowers who have already fallen victim to lenders' predatory private student loan practices. The House had a chance to start to make things right for these students in February but punted. Under pressure from the loan industry, the House defeated a measure that would have allowed borrowers in severe financial distress to discharge their private loans in bankruptcy.

But now that Congress is considering bailing out lenders for past risky financing decisions, we believe that lawmakers have an even stronger obligation to revisit the bankruptcy issue. Private student loans should not be treated any differently from other forms of consumer debt when it comes to bankruptcy. Folks who borrow private students loans are trying to better their lives. They certainly shouldn't be treated more harshly than those who rack up credit card debt at the mall.

We also believe that policy makers need to consider efforts to help borrowers who took on private loan debt before exhausting their federal student loan eligibility. They can do this by authorizing the Department of Education to offer a debt swap to these borrowers. Under this proposal, which we floated last month, the federal government could make new unsubsidized federal Stafford loans available for all borrowers (out-of-school or in-school) with private loan debt and untapped federal loan eligibility. These newly borrowed funds would have to be used to pay off existing private student loan debt. Presumably, a debt swap policy would ease the financial burden of private loan borrowers and infuse liquidity into the private student loan market.

These proposals -- for revising the bankruptcy law and authorizing a debt swap -- are reasonable steps that Congress can take to help out private loan borrowers in dire straits. Borrowers with unmanageable debt loads may not be able to hire high-priced lobbyists or lavish lawmakers with generous PAC contributions, but that doesn't mean that they should be left out of the discussions. Because really, if we're talking about a bailout, who's more deserving?

This post was prepared by Stephen Burd and Michael Dannenberg.

An Unduly Difficult Standard to Prove

Stephen Burd — Wed, 20 Feb 2008 00:00:00 -0500

Yesterday, we took issue with arguments made by a key lawmaker who helped defeat a measure in the U.S. House of Representatives that would have allowed financially-distressed borrowers to discharge their private loan debt in bankruptcy.

In attacking the proposed amendment to the House Higher Education Act reauthorization legislation, Rep. Ric Keller of Florida, the ranking Republican on the House subcommitee on higher education, said that "the current system" offers borrowers who find themselves in dire straits with all of the relief they need. He argued that struggling borrowers can work with private loan providers to obtain "more flexible" repayment options. He also noted that private loan borrowers who demonstrate that repaying their loans would cause "undue financial hardship" can have their loans discharged in bankruptcy.

"The Bankruptcy Code," Keller said, "already provides a provision for undue hardship for those people who truly need it."

In yesterday's post, we noted that far from being flexible, private loan providers are often unwilling to help struggling borrowers find ways to make repayment easier. Today, we take a closer look to see how well the "undue financial hardship" standard works in practice.

Researchers from Tulane University tackled that question in 2005, when they conducted an empirical study of 286 undue hardship decisions involving student loan borrowers. The authors of the study, which was published in the University of Cincinnatti Law Review, found little statistical difference in the characteristics and financial circumstances of those borrowers who were successful in getting their student loans discharged [57 percent of the cases granted the debtor some form of relief] and those who weren't [43 percent of the cases]. The researchers -- Rafael I. Pardo, an associate professor of law, and Michelle R. Lacey, an assistant professor of mathematics -- concluded that bankruptcy judges have applied the undue hardship standard unevenly and even "haphazardly." They wrote:

"What has proved to be most troublesome regarding application of the law has not been the infrequency with which relief has been granted, but rather the haphazard fashion in which courts have determined whether a debtor's circumstances support a claim of undue hardship that warrants forgiveness of educational debt."

Ultimately, whether or not one receives a discharge depends largely on the judge hearing the case, the researchers say. Judges have wide discretion, because Congress never adequately defined how courts should apply the undue hardship status. As a result, many judges have taken to making value judgments based on whether they believe individual borrowers deserve to have their loans discharged. These judgments often rest on the court's evaluation of "the debtor's prebankruptcy conduct." In other words, judges tend to try to assess "whether the individual debtor's bankruptcy stems from irresponsibility or rather true misfortune."

For example, some judges have faulted borrowers for their career decisions. In those cases, the courts have questioned whether borrowers who chose to pursue a low-paying career truly made "a good faith effort" to repay their debt. In one such case, according to the National Consumer Law Center, a judge denied a pastor's request for bankruptcy relief from his student loans "because his decision not to maximize his earnings, though commendible, was voluntarily made." In another, a borrower's bid was rejected because he had chosen to work as a cellist, rather than pursue a more lucrative position in the field he was trained. Yet a third court rejected the other courts' criteria, arguing that the fact that a debtor had chosen to work as a minister is "not by itself evidence of bad faith and should not be used against the debtor under undue hardship test."

While these are just a small sample of cases, they show how subjective and arbitrary are the determinations that different judges have made. In a recent case, Speer v. Educational Credit Management Corp., a lower court judge expressed frustration in his ruling that courts have received “absolutely no guidance” as to how to define “undue hardship” other than by using “a Webster’s dictionary.” That judge added:

"Basically, the application of this standard requires each court to apply its own intuitive sense of what “undue hardship” means on a case by case basis. With so many Solomons hearing the cases, it is no wonder the results have varied.”

Far from guaranteeing relief to those private loan borrowers "who truly need it," as Mr. Keller claims, courts have applied the undue hardship standard inconsistently, leaving many desperate private loan borrowers with no way out. Low-income and minority students who have fallen victim to predatory private student loan practices by Sallie Mae and other lenders -- and have not received a quality education -- should not have to hope and pray that they get lucky and have their case heard by a sympathetic judge.

The time has come for Congress to treat private student loans the same as other forms of consumer debt when it comes to bankruptcy. Hopefully, with a little education, Mr. Keller and at least several dozen of the other 235 lawmakers who voted against the amendment will have a change of heart.

A Missed Opportunity to Help Borrowers in Desperate Straits

Stephen Burd — Tue, 19 Feb 2008 00:00:00 -0500

The U.S. House of Representatives delivered a body blow to financially-distressed student-loan borrowers earlier this month when it voted down an amendment to a key higher education bill that would have allowed private student loans to be dischargeable in bankruptcy. Overall, the amendment, sponsored by Rep. Danny Davis (D-IL), failed by a vote of 179 to 236, with nine Republicans supporting the measure and 52 Democrats opposing it. But some very strange arguments were made.

In attacking the Davis amendment, Rep. Ric Keller of Florida, the ranking Republican on the House subcommittee on education, expressed sympathy for those who find themselves in dire straits and can't repay their loans. But then he argued that "the current system" offers them all the relief they need:

"Now what is a better way? The better way is the current system. You get out of school, you've got 10 years to make your payment, and if you can't make it, you work with the lenders for more flexible options, let you pay over 25 years. The Bankruptcy Code already provides a provision for undue hardship for those people who truly need it."

Sounds good, but far from being flexible, private loan providers have been notoriously unwilling to help struggling borrowers find ways to make repayment easier. And while it's true that private loan borrowers who demonstrate that repaying their loans would cause "undue hardship" can have their loans discharged, courts have defined that standard extremely narrowly and unevenly, leaving many desperate borrowers with no way out.

[slideshow]

Let's focus on Keller's argument that private loan providers provide borrowers with flexible repayment options. In making this point, Keller appears to confuse the terms and conditions of private loans with those of federal student loans. Most federal loan borrowers are expected to repay their loans in ten years. Those who are struggling can choose more flexible options, such as ones that allow borrowers to pay a smaller amount at first, and then increase the amount over time, or others that allow them to pay as a percentage of their income. Under the direct loan program's income contingency program and the new Income Based Repayment program, the federal government forgives any remaining balance after 25 years of repayment.

Private loans, on the other hand, typically start off with a 15 to 25 year repayment term. By stretching out the repayment period, private loan providers can make the loans, which carry high interest rates and fees, look cheaper because borrowers' monthly payments are lower than they would be under a 10 year plan. Because the standard repayment period is so long, most lenders are reluctant to extend it. Sallie Mae does allow borrowers to stretch out their payments on the company's private Signature Loans from 15 to 30 years, but appropriately warns that doing so will significantly increase the borrower's total debt load.

Borrowers in the federal programs who become unemployed or suffer economic hardship have a legal right to have their loans deferred for up to three years. Private loan borrowers who run into trouble don't have that option. And unlike federal loans, private loans are not automatically discharged if a borrower dies, is permanently disabled, or attends a school that unexpectedly shuts down before that student completes his or her studies.

At Higher Ed Watch, we have heard from many struggling and frustrated private loan borrowers who complain that their lenders have refused to work with them to make their payments more manageable. One such borrower wrote to us in July, saying:

"You can't rehabilitate a private loan and get back into a life of prosperity and financial responsibility when a private lender will not offer you the opportunities to do so, and perhaps even adds 25 percent in fees if you go into default due to unforeseen circumstances."

Mr. Keller, the current system is not "the better way," because it does not operate the way you seem to think it does. A truly better way would be to treat private students the same as other forms of consumer debt when it comes to bankruptcy. Right now, they aren't, 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.

An effort to fix the system failed this time. But hopefully if lawmakers spend more time listening to actual private loan borrowers, and less time listening to the spin of loan industry officials, they will learn how the system really works and will demand change.

Bankruptcy Fight on Private Student Loans

Ed Policy — Thu, 07 Feb 2008 00:00:00 -0500

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.

[slideshow]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.

A Gaping Hole

Ed Policy — Tue, 13 Nov 2007 00:00:00 -0500

The leaders of the House Committee on Education and Labor introduced legislation on Friday that would go a long way in addressing consumer advocates' biggest concerns regarding private student loans. The Higher Education Act reauthorization bill would, for instance, bar colleges and lenders from making

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

A Bankrupt Argument

Ed Policy — Tue, 28 Aug 2007 01:00:00 -0400

In 2005, Congress tucked into the bankruptcy bill a provision making it virtually impossible for borrowers to discharge private student loans. That provision -- which was added in a secret conference committee, received no public debate, and had no named Congressional sponsor --represents a glaring example of politicians serving corporate interests over regular people.

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Roundup: Week of June 11 - June 15

Ed Policy — Fri, 15 Jun 2007 01:00:00 -0400

House Committee Embraces New America's Loan Auction Proposal

The House Education and Labor Committee has embraced the New America Foundation's proposal to use an auction mechanism to set student loan subsidies. The Committee unanimously adopted…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

The Big Gun in the Loan Industry's Arsenal

Ed Policy — Thu, 07 Jun 2007 01:00:00 -0400

One of the reasons our debt-based college aid system puts up barriers to college access is that student loans are treated differently under the law than any other unsecured debt.

In the case of a defaulted student…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.

Private Student Loans: More Important than Child Support and Taxes?

Ed Policy — Wed, 30 May 2007 01:00:00 -0400

Last week, the Chronicle of Higher Education reported on an internal strategy document from Sallie Mae listing the company's goals in lobbying the new Congress. Not surprisingly, at the top of the list was the need to "Protect FFELP economics" -- in other words, to preserve…

Note: This post pre-dates Higher Ed Watch's shift to a new publishing system. For the complete original post, including any comments, please click here.