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Will Change in Bankruptcy Law Affect Student Loans?

By Tanya Roth, Esq. on May 07, 2010 | Last updated on March 21, 2019

Students might just have a lot more to thank Al Franken for than the years of laughs on Saturday Night Live. Senator Franken, along with fellow Democratic Senators Richard Durbin of Illinois, and Sheldon Whitehouse of Rhode Island, have reportedly introduced a bill that will make it far more possible for borrowers to discharge private student loans in bankruptcy, which have been generally shielded from bankruptcy discharge since 2005.

Currently, unlike other common forms of private debt such as car loans, credit card debt and mortgages, student loans from private lenders (typically banks) cannot be discharged by bankruptcy. As discussed by the NextStudent Student Loan Blog, under the Fairness for Struggling Students Act and its companion House bill, the Private Student Loan Bankruptcy Fairness Act, the debt students incur could be discharged in the same manner as other private debt.

Thanks to a provision the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act signed into law by then President George W. Bush, the current law only allows the discharge of private student loans in bankruptcy after a showing of "undue hardship," the same requirement that is made for federal or non-profit backed student loans. Undue hardship requires a separate showing to a bankruptcy judge proving, in essence, that the borrower would never be able to pay off the loan. This is an extremely difficult legal standard to meet.

NextStudent notes that several Republican legislators think the proposed changes are a bad idea. Congressman Trent Franks of Arizona believes the new law could tighten already restricted credit markets for young borrowers. "The exception from bankruptcy discharge that private student loans currently receive is vital ... ensur[ing] that private capital continues to flow into the student lending market," Franks said. If the credit market does constrict due to the new law, this could mean that only borrowers with the very best credit would have access to private student loans. Most people going off to college and in need of a private loan have not had the time or means to build up any, let alone a sparkling, credit history.

Opponents of the change in the bankruptcy laws often focus on whether it is unfair to leave the "undue hardship" bankruptcy exception in place for government-backed student loans, while allowing private loans to be discharged in bankruptcy without the same hurdle. Supporters say it is not the difference in the treatment of government and private student loans that should be discussed, but the difference in student loans and other private debt that is the real issue. According to NextStudent, Deanne Loonin, an attorney at the National Consumer Law Center, who was called to testify before the House, focused on what she says is an uneven playing field because of the lack of bankruptcy protection for student borrowers.

In her testimony, Loonin said that when she contacts student loan lenders on behalf of struggling borrowers to try to negotiate more manageable repayment terms, the lenders "offer virtually nothing." Without being able to discharge their private student loans in bankruptcy, financially distressed borrowers are left with no other choices, while on-going student loan payments keep them from being able to save money and get back on their feet.

"Basically, the most vulnerable borrowers are the least likely to be able to repay the loans," Loonin said, "and they are the ones who are hurting the most."

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