Bankruptcy Law – Student Loans
Another interesting article discussing proposed Bankruptcy Law andits impact on student loans
Student loan debt continues to be a cause for concern among American borrowers, despite recent shifts to make repayment easier on a substantial number of graduates. The majority of individuals have a difficult time paying for higher education costs out of pocket, given the nearly 6 percent inflation rate on tuition each year. To add to the financial pain, graduates over the last decade have experienced dismal prospects for high-paying, stable employment after earning an undergraduate or graduate-level degree. To combat some of these issues, the federal government made sweeping changes to repayment programs available to borrowers, including income-based options and forgiveness options after a set number of years.
Even with income-base repayment programs in place across all federal student loan programs, borrowers graduating in 2016 are burdened with an average of $37,172 in loans to repay over the course of their lifetime. Some borrowers who take out student loan debt to complete higher degree programs are apt to have two to three times more in outstanding loans ? a financial burden that is hard to champion even when no other consumer debt is owed. When other lending tools are used to finance life’s expenses, managing student loan debt becomes even more of an issue for some struggling borrowers.
One of the methods to get out from under the vicious cycle of debt payments is bankruptcy. Through a court process, individuals have the opportunity to cancel or negotiate down their outstanding debt due to financial hardship. However, as promising as bankruptcy may be for some indebted borrowers, consumers with student loans rarely had the option to utilize the courts to cancel or negotiate down federal or private debts used to finance their education. That may be changing soon.
Proposed Bankruptcy Amendments
Recently, democratic lawmakers proposed changes to legislation that would provide student loan borrowers the ability to discharge their education debt through the bankruptcy process. Under current law, borrowers filing bankruptcy do not have the option to cancel student loan debt unless they could adequately prove they experienced an undue hardship. For most, meeting this burden of proof is a near impossibility, leaving student loan balances and ultimately, repayment, still a reality after bankruptcy is filed.
The proposed amendment would allow borrowers to include student loan obligations in a bankruptcy filing if the lender servicing the loans failed to offer a debt relief option. The federal government offers the Pay As You Earn program, also known as PAYE, which gives borrowers the opportunity to cap student loan payments based on a percentage of their monthly income. After 20 years, the remaining balance of that borrower’s student loan debt is forgiven under the program. If private student loan lenders did not offer a similar program to borrowers, student loan debt could be canceled or significantly reduced through bankruptcy filing for qualified borrowers under the proposed legislative changes. To take things a step further, some lawmakers have introduced changes that would allow student loan borrowers to include all education debt in bankruptcy filing, even if a debt relief program similar to PAYE was offered directly from the lender.
While the efforts to reverse the student loan debt crisis are commendable in some circles, others fear the added bankruptcy protection paves the way for a downward spiral affecting the other side of the student loan coin.
Impact on Lenders and Investors
A shift in the lending marketplace has taken place steadily over the last ten years, with an influx of online lenders making the ability to apply for and secure affordable loans a reality for the vast majority of consumers. Online lenders like SoFi, Lending Club, and Common Bond have taken the reigns in the student loan arena, offering more attractive rates and repayment terms to borrowers who were dissatisfied with their private or federal student loan terms. While these new lenders have proven to be beneficial to borrowers from one standpoint, they do not offer flexible repayment programs that are linked directly to income nor do they provide any option for forgiveness after years of consistent repayment.
However, the inability to change repayment terms on a refinanced student loan makes for an attractive investment to outside investors. Protection of student loans against discharge through bankruptcy means that the balance of the loan will be repaid at some point in time, and investors are drawn to the less risky portfolio of online lender loans that include student debt than other packaged consumer debt portfolios. Online lenders have created billions of dollars worth of portfolio of student loans to sell to investors, known as SLABS. These bundled debt securities have received an investment-grade rating from agencies like Moody’s and Standard & Poor’s not only because of their inability to be dissolved in bankruptcy filings but because the lenders require fairly strict underwriting requirements to be met by borrowers prior to approving new loans.
With the proposed change in bankruptcy law under review, investors and lenders face an uphill battle in maintaining the value and the high rating of securitized student loan portfolios. Should the protection through bankruptcy disappear, borrowers may be more apt to default on their loan repayment knowing that discharging the debt is an option. If that were to take place in droves, the SLABS created by lenders would face a widespread downgrade, and investors would have cause to sue lenders offering the securitized debt as a way to recoup undue losses.
The proposed amendments to the bankruptcy laws may ultimately be beneficial to some student loan borrowers who are faced with an insurmountable burden of repayment. Being able to discharge debts through bankruptcy wipes the slate clean in terms of monthly debt obligations and capitalizing interest charges; however, borrowers filing bankruptcy face years of credit issues that are not easily overlooked by new creditors, including mortgage lenders, auto finance companies, and personal loan providers. Time will tell if the proposed changes to bankruptcy law will go into effect in the near future, but investors, student loan lenders, and borrowers all face continued challenges in the event the laws are changed.
By Drew Cloud
March 2, 2017 4:37 PM