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How bankruptcy could help solve the student loan crisis

Published: Friday, Aug. 23 2013 6:35 p.m. MDT

With the rise of borrowers defaulting on student loan debt, experts are suggesting ways that bankruptcy law could help.

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This week, President Barack Obama introduced a proposal that would give colleges federal money based on performance and affordability for students. Such measures, Obama said, would require accountability at institutes of higher education across the country in an effort to curb the escalating costs of student loans.

Experts say there may be an additional way to solve the student debt crisis: bankruptcy law.

Under the current system, it is all but impossible to get student loans wiped out through bankruptcy, unlike most other forms of unsecured debt such as credit card and medical bills. And legal experts say this is creating a generation of Americans who are unable to get out from under the crushing weight of college debt.

“If borrowers don’t have the money, they’re not paying anyway,” said Daniel Austin, a bankruptcy law professor at Northeastern University. “But because they can’t get loans discharged, they can’t participate in the credit economy. They’re off the economic grid. They’re the indentured generation."

The student loan burden

A substantial chunk of student loan debt has been a growing fact of life for many Americans. The Consumer Financial Protection Bureau found that total student loan debt is approaching $1.2 trillion, which would exceed credit card debt by more than 28 percent, using Federal Reserve data. Forty-five percent of all American families now have student loans, according to a report released this week by David Bergeron and Joe Valenti from the Center for American Progress, a progressive think tank. And the average student loan balance for a 25-year-old has jumped 91 percent from 2003 to 2012, from $10,649 to $20,326, a recent study from the Federal Reserve Bank of New York showed.

With unemployment high, particularly among young Americans — 12.6 percent for 20- to 24-year-olds compared with the overall rate of 7.4 percent, according to July's jobs report — default rates on student loans are on the rise as well. According to a New York Federal Reserve study, in 2011, 14.4 percent, or 5.4 million of the 37 million borrowers who had outstanding student loans, had at least one past due payment. That number is more than 7 million borrowers this year, according to the CFPB. And the 2013 New York Federal Reserve study showed the proliferation of student loans means that students are delaying other major life purchases like homes and cars and even delaying life milestones like marriage and having children.

“There’s this [idea] that if you go to college, then you’re able to get a job, and you’re on your way in life,” Austin said. “But education has become so expensive … and people are coming out of college with $50,000 to $100,000 in debt. Then they meet hard times and now they become this permanent underclass. It’s horrible. We ought not be doing that in this country.”

“… They’re in a different economy than we are," he said. "If we at least allow them to discharge that debt in bankruptcy, they can return to be participants in the economy.”

The muddled mess of bankruptcy law

Although bankruptcy reform legislation passed in 2005 placed a number of hurdles on the ability of people to file for bankruptcy, the number of filings jumped when the recession hit, according to the Wall Street Journal. While the number has decreased from the 2011 high of 1.53 million, slightly more than 1 million Americans filed for protection last year, according to Bergeron and Valenti. In bankruptcy, a borrower can wipe out most of his unsecured debt entirely, or repay a portion of it over three to five years. This gives what bankruptcy practitioners and courts have called a “fresh start.”

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