Should student loans be forgiven in bankruptcy court?

I came across this article this weekend that raised some interesting points about a push to allow private student loans to be forgiven in bankruptcy court:

If you run up big credit card bills buying a new home theater system and can’t pay it off after a few years, bankruptcy judges can get rid of the debt. They may even erase loans from a casino.

But if you borrow money to get an education and can’t afford the loan payments after a few years of underemployment, that’s another matter entirely. It’s nearly impossible to get rid of the debt in bankruptcy court, even if it’s a private loan from for-profit lenders like Citibank or the student loan specialist Sallie Mae.

This part of the bankruptcy law is little known outside education circles, but ever since it went into effect in 2005, it’s inspired shock and often rage among young adults who got in over their heads. Today, they find themselves in the same category as people who can’t discharge child support payments or criminal fines.

Now, even Sallie Mae, tired of being a punching bag for consumer advocates and hoping to avoid changes that would hurt its business too severely, has agreed that the law needs alteration. Bills in the Senate and House of Representatives would make the rules for private loans less strict, now that Congress has finished the job of getting banks out of the business of originating federal student loans.

Outside of bankruptcy there is already some movement in tackling the catastrophic impact of student loans.  For example, after ten years in public service and consistently paying your student loan, the remaining balance can be forgiven.  When the health care reform bill was passed, included in the bill was information about student loans including the ability to cap loan repayments at 10% of a person’s income.  And finally universities and banks are frequently under attack for giving loans, with congress considering in 2008 requiring all schools to disclose any relationship they may have with a bank and simplifying the financial aid process.

Yet being able to have student loans discharged in bankruptcy court is another issue.  This article comes on the heels of another article in the New York Times about a young woman from NYU who owes over $100,000 and is struggling to pay it off, planting an image of the reckless 19 year old who will want to declare bankruptcy just to avoid her personal responsibility.  However, that attitude ignores the realities of bankruptcy: 90% of all people who file for bankruptcy do so for one of the following three reasons: 1) divorce 2) health crisis 3) job loss. And the process of filing for bankruptcy can be expensive, arduous, as well with long term financial implications.

It’s also insulting in that it assumes that taking out student loans with the intention of making enough to pay them back is  somehow more egregious than folks who take out loans to buy boats and cars for fun. There is a desire to scold young people for doing what people tell us we should be doing “Go to school!  Get an education!  Get a good job!” when all of these things are subjective and not guaranteed.

But the fact that you could discharge privately backed student loans in bankruptcy court before 2005 makes me wonder what the hold up is in readdressing this issue.  If we were to look back at data before 2005 on declaring bankruptcy, will it be skewed toward young people holding massive amounts in student loans?  How do we address other issues when it comes to rising costs in education like how many colleges often raise prices to be competitive not meet actual needs?  Is this a time to advocate for larger system reform when it comes to how we on an individual and national level finance education?

So what are your thoughts on the current state of student loans?

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