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Can Bankruptcy Solve Student Loan Woes?

A federal agency is asking Congress to consider letting people wipe out some of their student debt by filing for bankruptcy protection. Consumer advocates, however, say the move will do little to help the vast majority of families struggling with college loans.

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Richard Cordray, director of the Consumer Financial Protection Bureau, suggested the change to the bankruptcy rules Thursday in conjunction with a report criticizing private lenders. A 2005 law preventing borrowers for wriggling free of private student loan debt in bankruptcy failed to prompt lenders to lower rates as promised, he said during a press call.

But even if Congress changes the private-loan policy, federal loans – which account for around 85% of the more than $1 trillion in outstanding student debt – would still not be dischargeable through bankruptcy, says Mark Kantrowitz, publisher of FinAid.org, a student-loan tracker. And the federal loans are not only much more common, they default at nearly twice the rate. Approximately 9% of the total dollar amount of federal loans outstanding is in default compared to roughly 5% of private student loan dollars, according to data from the Department of Education and FinAid.org.

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The recommendation comes at a time when student debt is rising rapidly. Since June 2005, debt has soared from $430 billion to more than $1 trillion, with many Americans across all age groups struggling to keep up with payments. With the aim of easing some of that burden, last month Congress voted in favor of extending the 3.4% rate on federal subsidized Stafford loans for one more year. Rates on those loans, whose interest is paid by the government while borrowers are in school, were set to double if Congress didn’t intervene. Experts say more aid may come soon.

Though private loans are often criticized for giving borrowers fewer options to stretch out payments in times of distress, the repercussions for those behind on federal loans are often worse. Private lenders and the federal government can both garnish borrowers’ wages, but the government has a much greater reach. After borrowers default on federal student loans, the government can also keep their income tax refunds and withhold part of their Social Security checks during retirement.

Roughly 850,000 private loans that went into repayment from 1998 to 2009 are in default, according to the CFPB. During that same period, nearly 2.1 million federal student loan borrowers defaulted within two years of entering repayment, according to data from the Department of Education.

But allowing federal loans to be discharged through bankruptcy may be a nonstarter, officials say, as taxpayers would be saddled with the cost.


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