Fairness for Struggling Students Act of 2015: Bankruptcy Relief may be on the Horizon for Private Student Loans

A legislative proposal is finally pending with Congress as a first step to help ease the student loan crisis. Sponsored by Sen. Durbin of Illinois in conjunction with Sen. Franken of Minnesota, the Fairness for Struggling Students Act was proposed in March 2015 to remove the Bankruptcy Code’s exception from discharge of private student loans. Short and simple and to the point, the full text of the bill can be read here.

Private student loans account for as much as 20% of the total $1 trillion student debt load in the U.S. And just as with the more common federally subsidized loans, currently there is no relief in bankruptcy for private student loan principal or interest. For borrowers in default, the effect of reversely amortized interest on private student loans can quickly multiply the balance in only a few years.

According to the U.S. Department of Education, between 13% and 15% of all student loans are in default. This is almost triple the low default rates of the early 2000s. And with student loan borrowing on the rise and income rates not keeping pace with inflation, the default rate can only be expected to increase. Unlike other unsecured debts, student loans currently are almost never discharged in bankruptcy except in very rare circumstances of total and permanent inability of the borrower to repay.

While federal student loans are subsidized by the federal government–common examples are Direct Loans, Parents PLUS Loans and Perkins Loans–private student loans are funded by banks, credit unions and other private lenders or even the school itself.  Because private loans are not guaranteed by the government, these loans typically carry higher and variable interest rates, may require repayment during enrollment, often demand a certain credit rating and cosigner, and are not eligible for consolidation or loan forgiveness programs for public servants. To say the least, private student loans have similar repayment conditions as credit cards (noting that credit card companies factor the possibility of bankruptcy into the high interest rates charged), yet private student loans have none of the relief options in bankruptcy that one has for their credit card debt.

Prior to October of 2005, it was possible to discharge private student loan debts in chapter 7 and chapter 13 bankruptcies while federal student loans have historically remained non dischargeable. However with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), essentially every type of student loan–both public/federal and private– cannot be discharged in bankruptcy.

If passed, the Fairness for Struggling for Students Act will effectively reverse the 2005 changes to the Bankruptcy Code and once again make private student loans dischargeable in a bankruptcy proceeding. Under the Act, private student loans would be treated the same as credit cards, i.e., bankruptcy would discharge private student loan debts same along with most other general unsecured debts such as credit cards and other unsecured loans.

Be sure to read more about student loans and relief options at the Wartchow Law’s Student Loan Blog.

More on the National Crisis of Defaulted Student Loans: the Income Based Repayment (IBR) Program is One Option to Avoid Wage Garnishment

The student loan debt predicament is to the 2010s what the foreclosure/subprime lending crisis was to the 2000s. Student loans are a massive consumer debt issue that reaches every economic earnings level, from the underemployed recent graduates unable to find a career in their chosen profession, to the experienced professionals earning a median income. Student loan debt service is simply expensive, even for the average employed professional. And little relief is currently available from the federal government or otherwise.

(Read more of my continuing student loan debt blog: The Student Loan “Debt Bomb”: With Student Loan Debt Out of Control, What Can Bankruptcy (and Congress) Do to Help?)

According to Forbes.com in late 2014, the total student debt load in the U.S. is over $1 trillion dollars, a number which comparatively represents about 10% of the amount of outstanding mortgage debt in America. As of early 2015, the interest rate on Stafford is presently 4.66% for undergraduate loans and 6.21% for graduate loans.

As a practical example, a recent graduate from a 4-year public university with an average student loan debt of $30,000 will repay their student loans at $272 per month for at least 10 years. Add a graduate degree to the calculation with the additional average debt of $57,600 and that monthly student debt expense jumps to $917 per month for ten years.

For the average single income earner in Minnesota with a graduate degree and carrying the national average student debt load, this means that approximately 28% of their take-home pay will be devoted each month to student loan debt service alone. Try affording a mortgage, credit card payment or child care with that much income devoted to student loan debt service.

The result is widespread student loan default. A defaulted student loan, like any other unpaid debt, can aggressively force repayment via wage garnishment of 15% of one’s take home income. When this happens, the defaulted borrower may not be able to afford their other basic living expenses such as housing, utility and food expenses. Thus the defaulted student loan can snowball into a series of unfortunate events including accumulation of credit card debt used to purchase such basic expenses, to eviction, foreclosure and even bankruptcy. And while bankruptcy usually provides relief from other debts, it will not discharge student loan obligations so that the crisis continues during and after a bankruptcy is filed. All the while, interest continues to accumulate on both the unpaid balance and the unpaid interest—resulting in reverse amortization that can easily double the balance due in a matter of several years. (Forbearance or an allowed temporary suspension of payments may also result in reverse amortization of the loan balance, and often this option is best avoided for this reason.)

One of the few forms of relief available for student loans is the federal Income-Based Repayment program, also called the “IBR” program. Under the IBR program, student loan repayments are capped at 15% of one’s discretionary income. Discretionary income is calculated as the difference between one’s most recent adjusted gross income (AGI on the last federal tax return Form 1040), less 150% of the applicable poverty line for your state and family size. Additionally, you must be able to demonstrate a financial hardship and meet other personal and loan eligibility requirements. Parents PLUS loans are almost never eligible for the IBR program however most other federal student loans will qualify.

For more information on the federal Income-Based Repayment program, see the IBR page of the Federal Student Aid website operated by the U.S. Department of Education.

For assistance with applying for the IBR program and other debt resolution, contact Wartchow Law Office for a free consultation to discuss your options.

The Student Loan “Debt Bomb”: With Student Loan Debt Out of Control, What Can Bankruptcy (and Congress) Do to Help?

A new financial catastrophe is facing Americans, and it’s quickly becoming America’s latest and greatest “debt bomb”. According to the National Association of Consumer Bankruptcy Attorneys in August 2014, there are 7 million Americans in default on over $100 million in student loan debt, and the total student loan debt carried by Americans (defaulted and non-defaulted) is an enormous $1.2 trillion. To put this confounding figure into context, $1.2 trillion dollars is equivalent to 1,200 billion dollars, or over a million million dollars. $1.2 trillion is enough to buy a new Prius for about half of all American households, or to pay Congress’s salaries for over 11,000 years.

To measure the extent of the student loan crisis on Americans, simply compare this $1.2 trillion in federal and private student loan debt to the total $1.3 trillion in toxic subprime mortgages that coincided with America’s most recent recession. The foreclosure crisis of the 2000s has now (and almost dollar-for-dollar) been replaced by this decade’s student loan crisis.

Currently there is nearly nothing that filing bankruptcy will do to cauterize the student loan crisis. But a wave of change is on the horizon.

As recently as ten years ago and prior to the 2005 amendments to the Bankruptcy Code, most private student loan debt was dischargeable in a bankruptcy proceeding.  However for the past ten years, debtors have found no relief for their student loan debt in bankruptcy: bankruptcy will not even discharge late fees or reversed-amortized interest due on accrued interest, which can have the effect of doubling the amount due on a defaulted student loan. In a penalizing twist of fate, chapter 13 debtors can emerge from a 5-year chapter 13 plan actually owing as much as twice more on their student loans than when they first filed chapter 13.

U.S. Congress is presently considering reform to higher education legislation, including possible relief for private student loan* debt in bankruptcy.  The suggested student loan bankruptcy reforms include fast-track discharge for private student loans in cases of death or permanent disability, discharge where the private lender has failed to offer the borrower deferment and forbearance options, discharge of private student loans that carry unreasonably high interest rates, and discharge of both federal and private student loans which are granted from institutions having high drop out and default rates (i.e., many for-profit institutions that target low-income students and where success is measured by profit rather than graduation rates).

To date, Congress has done nothing to meaningfully address bankruptcy reform as the student loan crisis continues to drive generations of Americans into widespread default with no avenue for even a moderate relief in the form of restructure of student loan interest rates, late fees or accrued interest.

*Private student loans are not funded by the federal government, which means these loans are obtained directly from banks, credit unions, schools and other market lenders at usually higher interest rates that compare to credit cards. Unlike federal loans, private student loans cannot be consolidated, often require a co-signer and may require payments due while the student is still in school.  Critically unlike federal loans, private student loans may not offer forbearance or deferment in situations of medical or financial hardship.

Wartchow Law Office provides free bankruptcy consultations to discuss options in Chapter 7 and Chapter 13 consumer bankruptcy as well as non-bankruptcy debt relief alternatives.