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White House Floats Bankruptcy Process for Some Student Debt
March 10, 2015
The White House is weighing steps to make it easier for Americans to expunge certain student loans through bankruptcy, opening the door for student debt made by private lenders to be treated on par with credit-card debt and mortgages.
Federal law prohibits student loans, from private lenders and from the U.S. government, from being wiped out in bankruptcy, except in rare circumstances. Other forms of consumer credit such as mortgages, credit-card balances and auto loans face looser requirements for being discharged in bankruptcy.
President Barack Obama on Tuesday directed administration officials to study whether to expand bankruptcy options for “all student loan borrowers.” An administration official said the bankruptcy review would likely focus on whether to expand bankruptcy options for borrowers with student loans made by private lenders—such as SLM Corp. ’s Sallie Mae and Wells Fargo & Co.—that aren’t backed by the government.
Private loans make up about 10% of all student loans, with the remaining 90% made by the federal government.
Any bankruptcy-law changes would have to be approved by the Republican-controlled Congress, which has broadly opposed the president’s agenda.
Expanding bankruptcy options for some student debt would come as the government also is expanding programs that lower students’ monthly payments and ultimately forgives some debt. The lending industry has argued that loosening the student-loan rules would drive up borrowing costs for everyone, because lenders would raise rates to account for the additional risk of bankruptcy.
Total student debt has more than doubled since 2007, and nearly a quarter of borrowers out of school now are behind on payments, Federal Reserve data show. And while the average burden among recent college grads is just under $30,000—a sum many economists consider reasonable—a small but growing share owe substantially more than that. Many of those borrowers are graduate students making decent incomes, but some are former students and their parents who make modest or no salaries.
“We’re trying to make sure that across the board, more and more young people can afford to go to college, and then afterward, aren’t so burdened with debt that you can’t do anything else,” Mr. Obama Tuesday said at Georgia Institute of Technology.
The lending industry’s main trade group, the Consumer Bankers Association, said in a statement that less than 3% of Americans with private student loans are in “financial distress.”
“We are working to provide flexible repayment options to keep them from finding themselves in bankruptcy at all,” the group said.
Mr. Obama’s effort is part of a broader White House initiative that also includes setting up a system for borrowers to register complaints about the companies, known as servicers, that collect student-loan payments on behalf of the government. The servicers would face stricter federal oversight and new rules designed to make them more proactive in reaching out to distressed borrowers and offering better repayment terms.
Fewer than 1,000 people try to get rid of their student loans every year using bankruptcy in a process that is both expensive and uncertain: It involves filing a lawsuit in federal court, and lawyers typically charge several thousand dollars upfront for that work. A Wall Street Journal analysis found 713 such lawsuits were filed last year.
Student loan borrowers who filed for bankruptcy in 2013 had an average of $32,096 in student-loan debt, compared with the average of $13,456 for those who filed in 2006, according to a figures kept by Northeastern University professor Daniel Austin.
Many bankruptcy lawyers say they are hesitant to take on these cases because of the wide range of rulings that judges have handed down. In court, lawyers for a bankrupt student-loan borrower have to convince the judge that the borrower will never be able to afford their monthly payments—a difficult case to make.
Starting in 1976, federal loans were automatically dischargeable after five years of repayment, but borrowers could get out of them earlier if they proved that repaying them would cause an “undue hardship.” But that benefit was gradually removed, and student loan borrowers now need to establish “undue hardship” no matter how many years of federal loan payments they have made.
In 2005, Congress passed a sweeping bankruptcy overhaul for consumers that made private student loans nondischargeable as well.