Remember When Private Student Loans Were Dischargeable in Bankruptcy?
Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), private student loans were indeed dischargeable in bankruptcy. By contrast, educational loans issued or guaranteed by the federal government have been nondischargeable in bankruptcy since the U.S. Bankruptcy Act of 1978.
Since BAPCPA’s passage in 2005 and its exception of private student loans from bankruptcy discharge, we’ve seen nothing less than a financial vortex in this country. The burst housing bubble in 2006, ongoing recession, and high unemployment. Many borrowers of unmanageable private student loans are suffering greatly. They may have lost their jobs to downsizing, lost their homes to foreclosure, and lost their vehicles to repossession. Yet under BAPCPA, they still have to find a way to pay their private student loans after bankruptcy. Adding insult to injury, unlike federally-backed educational loans, private student loans do not include Income Based Repayment and deferment options. Lastly, when burdened with private student loans after bankruptcy, these debtors will have few home-buying opportunities, which may prolong the goal of economic recovery in our housing market.
Sallie Mae’s Role in Lending to Students
Sallie Mae (SLMCorporation) is the nation’s largest lender of private student loans. The lending of educational loans generates big money for investors, especially when the risk of non-payment is so minimal thanks to the BAPCPA. Today, Sallie Mae’s private student loan portfolio is about $36 billion.
Sallie Mae expects to originate another $3.2 billion in loans this year alone – that’s up from $2.7 billion last year. Presumably, a fair number of these new borrowers already count themselves among the unemployed or underemployed. These loans represent real people who are gambling on their talent and ability to learn in hopes of increasing job opportunities in a long-depressed economy. If the gamble does not pay off quickly, they may find themselves deep in debt with no relief valve.
Perhaps surprising to some, Sallie Mae favors dischargeability of private student loans in bankruptcy, but under very limited circumstances. According to Fannie Mae’s Patricia Nash Christel:
“Sallie Mae supports reform that would allow federal and private student loans to be dischargeable in bankruptcy for those who have made a good-faith effort to repay their student loans over a five-to-seven year period and still experience financial difficulty.”
Educators In the Business of Education
Of the $36 billion in private loans, about 90% pay for programs at non-profit educational institutions. The remaining 10% of the institutions receiving Fannie Mae private loans are for-profit colleges. Some for-profit colleges are niche-oriented, are very expensive, and may be unaccredited (which means the degree earned is neither marketable nor transferable to another college or university). Government grants and loans account for about 90% of the revenue coming into for-profit colleges.
Arguing Elimination of BAPCPA’s Student Loan Exemption from Discharge
Some argue that eliminating the exemption of private student loans from bankruptcy discharge will only hurt the innocent lenders who made the loans possible.
Others argue that eliminating the private student loan exemption will increase the cost of education for everyone. Lenders will be less willing to lend because a return on their investment involves a much greater risk. Typically, the riskier the investment, the higher the interest rate will be on the loan. Furthermore, fewer people will qualify for any private student loans under potentially strict new lending guidelines.
Yet others argue that eliminating the exemption will only create a loan climate where the borrower seeks large unsecured amounts knowing that escape from repayment will be easy. Borrowers will know that they can eliminate the debt through bankruptcy, so why not borrow as much as one can and shoot for the stars?
Still others, like Senator Mike Enzi (R-WY), argue the private student loan exemption should remain in place. Instead, he believes the focus should be on the ever-increasing cost of higher education in this country. Enzi points to the help already available to those borrowers struggling with their loan obligations. According to Enzi, “[r]ecognizing that many Americans may encounter unexpected financial difficulties during the repayment of their student loans, Congress has already enacted a variety of protections to help student loan borrowers avoid default and protect their credit.”