Private Student Loans May Soon Be Dischargeable in Bankruptcy

A bill making its way through the U.S. House of Representatives would allow private student loans to be discharged in bankruptcy, reversing an earlier law that made student debt essentially non-dischargeable.

When President George W. Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act into law in 2005, the goal was to reform bankruptcy and to make it more difficult to take advantage of bankruptcy protection. However, the bill had a harsh effect on those with student debt: under the law, private student loans are exempt from discharge in bankruptcy in the vast majority of cases.

The 2005 law reclassified private student loans as “education loans”, placing them in the same category as government-backed federal college loans, which are not eligible for discharge in bankruptcy. Therefore, in order to have private student debt erased, borrowers must show that repaying the loans would result in “undue hardship”, an almost impossible standard to meet.

Many have criticized the undue hardship threshold – which does not apply to credit card debt, car loans, or home mortgages – as an unfair burden on borrowers. “People who borrowed for college and played by the rules deserve basic consumer protections and fair treatment when they hit hard time,” said Lauren Asher of the Institute for College Access and Success.

However, this may soon change. The Private Student Loan Bankruptcy Fairness Act, which was introduced into the House of Representatives in April, would reverse the provision of the 2005 law that classified private student loans as non-dischargeable debt. The bill was recently passed by a House subcommittee, and the legislature is expected to take further action before the session ends in four weeks.

According to Asher, the new law simply balances the field, treating private student loans like other, similar debt. “Under the legislation,” Asher said,” private student loans would once again be treated like other consumer debt in bankruptcy, rather than like unpaid criminal fines.”

Source: NextStudent, “Bankruptcy Protection Bill for Private Student Loans Advances in Congress”, Shannon Rasberry, 7 October 2010