Keeping Student Loan Interest Rates Low Is Good, But What We Really Need Is to Reform the Law to Allow Discharge of Student Loans in Bankruptcy

Student Loan Debt Ought to Be Discharged in BankruptcyIn my last post, I noted the fact that Americans are now saddled with over $1 Trillion in student loan debt, more than all of us combined owe to credit cards. And as I also wrote, Congress has made it next to impossible to discharge student loans in bankruptcy. To be discharged in bankruptcy, the debtor must prove that repaying student loans will impose an “undue hardship” (a legally opaque standard). This standard used to apply only to government backed student loans, but the 2005 BAPCPA changed this rule to likewise make private student loans nondischargeable except in the most extreme cases where debtors can prove present, and likely permanent, poverty. By placing the burden of proving the likelihood of future poverty on the bankruptcy debtor, this imposes an enormous chilling effect on debtors seeking debt relief from student loans because the debtor, who is already in bankruptcy, has to be able to afford to litigate this issue with the student loan lender. The absurd result is that it is easier to obtain a bankruptcy discharge of back income taxes owed to the federal government than it is to discharge private student loans owed to Citibank.

Keeping the present interest rate at 3.4% for federally subsidized Stafford loans rather than allowing that rate to double to 6.8% in July, will not prevent the coming crisis in student loan defaults. That won’t happen without amending the Bankruptcy Code to offer a common sense approach to debt relief from student loans for a greater number of bankruptcy debtors. But keeping the interest rate low on federal student loans will help curb student loan debt balances from ballooning even further than they otherwise will if the rate is allowed to double.

Enormous student loan debts cause young people to delay or forego altogether getting advanced professional degrees, purchasing homes, having children, and starting businesses. And, of course, the prospect of crushing student loan debt discourages many from attending universities and graduate schools in the first place. Given that we need this and future generations to do these things for the good of our long term economy, it’s just dumb public policy to allow student loan interest rates to double.

Now, we can disagree about where the money should come from. Not wanting to totally alienate college age voters in an election year, the Republicans are now on board, it appears, to keep these rates low, but have proposed taking the money to pay for it from a fund created for health care. The Democrats prefer to pay for it by eliminating subsidies to oil and gas companies. That should be a pretty easy choice for any middle class families who might be paying attention. One piece of advice to parents: start a 529 college savings plan now; 529 college savings are even protected in Chapter 7 bankruptcy.

In the end, however, we will still face a huge rate of defaults on student loans in the coming decades as the overall amount of student loan debt continues to balloon. Default rates, which have been historically low compared to other types of debt, are already on the rise. As private student loans become more prevalent, imposing much higher interest rates and refusing to offer consolidation options or meaningful help to borrowers struggling and unable to pay, the default rate will continue to grow. Because they cannot be discharged in bankruptcy for all practical purposes, we risk creating a future permanent underclass of college educated people whose wages will be garnished into their retirement years. While it is certainly in the best interest of our future economy to keep federal student loan interest low, what we really need is to reform the Bankruptcy Code to allow for the discharge of student loans where debtors demonstrate a reasonable history of effort to pay their student loans but a present inability to pay them, not an absurd standard of probable future poverty as is the current case under the judicially created Brunner test of “undue hardship.”

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