Getting Out of Student Loans

One of the more troubling aspects about the rise in student loan debt is that, unlike other forms of debt, this generally isn’t dischargeable in bankruptcy. When someone files for bankruptcy he gets relief from creditors. But that doesn’t work for student loans. People are still responsible for payments on those debts, crippling interest rates an all, even if they file for bankruptcy.

It’s time to change that. According to an editorial in the New York Times:

Legislation is pending in both houses of Congress that would make private school loans dischargeable through bankruptcy, as most of them were before Congress changed the law in 2005. It had long been the case that federally backed student loans were protected during bankruptcy proceedings. That is reasonable, since those loans were backed by taxpayer dollars and flexibly structured so that borrowers could receive deferment in tough times and resume payments when their finances improved.

The country has a compelling interest in making it as difficult as possible for student borrowers to elude payment for federal loans. There was no reason for extending that protection to private lenders of student loans.

There is, from a student-interest perspective, no reason at all to prevent the indebted from discharging their loans in bankruptcy. The moneylenders, however, are very interested in keeping this provision in place, since it allows them to lend money to very risky people without worrying about getting their money back.

Under normal circumstances banks have a disincentive to loan money to people who are credit risks; if the debtors can’t pay their money back they file for bankruptcy and don’t have to. This is obviously something banks want to avoid. But student loans are a real bonanza for money lenders; even if students can’t really afford to make payments on their loans the law forces them to do so. Let’s see if the banks and their lobbyists will allow this interesting situation to change.

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Daniel Luzer

Daniel Luzer is the news editor at Governing Magazine and former web editor of the Washington Monthly. Find him on Twitter: @Daniel_Luzer