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Student Loan Dischargeability in Bankruptcy

Bankruptcy offers a fresh start to many facing mounting credit card bills, unaffordable car payments, or mortgage installments that can no longer be met – but it provides no relief to those with student loan debt. Student loans are generally not dischargeable in bankruptcy, even private loans from for-profit lenders. According to the New York Times, pending legislation could change this: current Senate and House bills would allow students to discharge private student loans.

Pending Legislation Affecting Student Loans

There are two main types of student loans: federal loans are issued or backed by the federal government and therefore ultimately by taxpayer dollars; private loans, on the other hand, are underwritten by for-profit banks and come with fewer repayment options. Since 2005, private and government-issued or -protected loans have been generally nondischargeable in bankruptcy.

Senator Dick Durbin’s website reports that, along with other Democratic lawmakers, he has introduced legislation that would loosen restrictions on whether privately issued student loans could be discharged in bankruptcy.

Weighing the Options

John Hupalo, a managing director Samuel A. Ramirez and Company, challenges the pending changes, asking what incentive students, with a new degree in hand and no tangible assets to lose, would have to refrain from filing for bankruptcy without ever making one payment. Representative Steve Cohen countered that there are practical reasons to avoid filing for bankruptcy, including that people do not like to go through a bankruptcy. Additionally, individuals would not be able to file for bankruptcy again for years, bankruptcy filings are damaging to credit reports and those seeking only to shirk their payment obligations would have a difficult time finding a bankruptcy lawyer willing to risk his or her license to take a frivolous case.

Private lender Sallie May reportedly is agreeable to the changes so long as there is a waiting period before students can try to discharge their debts, during which time, the former student or graduate make a good faith effort to pay as promised.

Some lenders also say the proposed legislation would result in fewer loans being available. Hupalo says student borrowers are “not creditworthy to begin with, almost by definition.” It may become more difficult for students to get private loans or more banks may require a co-signor so that two adults are obligated for repayment of the debt instead of just one.

If lenders assume the worst – that students would file for bankruptcy en masse upon graduation – then borrowing costs could potentially increase. Even so, some argue this could drive the cost of college down. If loans cost more and lenders underwrite fewer of them, this argument goes, people will have less money to spend on education, forcing profit-making schools to lower prices or close, leaving only popular private nonprofit universities.

Students who have concerns about meeting their student loan payments should talk to an experienced attorney about debt relief options.

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