One solution lawmakers put forward in the growing debate over student loans is to forgive the debt of some borrowers who file and get approved for bankruptcy. But experts say even if Congress passes such legislation, banks have already taken the measures to ensure it won’t work.
Two bills introduced last year — the Fairness for Struggling Students Act and the Private Student Loan Bankruptcy Fairness Act of 2011 — are suddenly in the center of a national debate over Americans’ skyrocketing student-loan debt. Both bills would give borrowers who have bankruptcy courts forgive their debts a way out of the private, but not Federal, college loans that they’re unable to repay. Unlike most consumer debt, including credit cards, car loan and mortgages, student loans currently cannot be wiped out after bankruptcy. Those whose debts are dismissed in bankruptcy today are still on the hook for their student loan payments.
While the legislation is aimed at helping thousands of borrowers struggling with debt, some experts say banks seem to have prepared for this possibility. Since they now require cosigners on most of the loans, both the borrower — and in many cases his or her parents – would need court-approved bankruptcies in order to wiggle free of the debt. And the law could have broader consequences, experts say, such as more stringent requirements to qualify for student loans, and slightly higher rates.
More than 90% of college loans private lenders have doled out since the credit crunch have co-signers, says Mark Kantrowitz, publisher of FinAid.org, which tracks financial aid and student loans. That’s up from roughly 50% prior to 2008. The chances both the borrower and co-signers would obtain bankruptcy discharges together are slim, he says. Since the recession, lenders have been thoroughly vetting co-signers to make sure they have top credit scores, pristine credit histories, and low debt compared to their income, say experts, and in many cases those co-signers end up being the students’ parents.
Of course, a new law could help those students who signed up for a private loan when lending requirements were loose. Chances are many of them didn’t have a co-signer or a co-signer could have been a friend whose own credit may be in the dumps now. It’s also unclear whether either of these bills will make headway. At least six bills have been introduced since 2006 to make student loans dischargeable and none of them have come to fruition.
But should the law be passed, students seeking loans in the future could find financing even harder to get than it is now. A report by the Consumer Bankers Association, which represents student loan lenders, states that pending legislation “could discourage lenders from offering private student loans or result in an increase in pricing (e.g. interest rates) to reflect additional risk.” For students, options for private loans have been shrinking for some time: There are now 22 lenders providing private student loans, down from about 60 before the market crash, according to FinAid.org. Last month, US Bank became the latest lender to exit the market.
It’s unclear how much rates on private loans could rise. Kantrowitz says the increase would likely be small, and might impact the upfront fees students pay on these loans rather than the rate.
For their part, private lenders say they represent a small part of the student loan market. Less than 7% of the student loans projected to be made during the current academic year — roughly $7 to $8 billion — are private student loans, according to the CBA. (The CBA didn’t return calls for comment.) Meanwhile, 93% or $111 billion are projected to be federal student loans. Separately, about 84% of outstanding student debt consists of federal student loans.
Like private loans, federal loans aren’t dischargeable in bankruptcy. Neither of the bills call for federal loans to be discharged. Consumer advocates say it’s because taxpayers would ultimately be on the hook to pay for those losses.
When borrowers default on private loans, private lenders can garnish their wages (with court approval) and can go after some assets like cash in a bank account. But with federal loans, borrowers who’ve defaulted could risk losing even more: In addition to garnishing wages, the government can keep their federal and state income tax refunds, intercept future lottery winnings, and withhold part of their Social Security payments.