Are student loans similar to subprime mortgages?

The newly-created Consumer Financial Protection Bureau (CFPB) is making more news this week, but not because of any regulatory fines or punitive actions.  This time, the CFPB is advocating that borrowers who took out private student loans should be able to discharge those loans in bankruptcy.  The CFPB, along with the U.S. Department of Education, advocated for this position, partially linking private student loans to subprime mortgages.  Student loan debt in the United States has ballooned to over $1 trillion as of 2011.  Of that total, more than $150 billion is debt issued by private companies.  Part of the reason for the push to make loans dischargeable in bankruptcy is that many private loans were issued to borrowers who could not likely repay them.

Because of lax regulations and poor underwriting, over $8.1 billion in private student loan debt has gone into default.  Unfortunately for borrowers in default, recent changes to the Bankruptcy Code have made it nearly impossible to discharge student loans in a bankruptcy.  The CFPB has indicated that troubled borrowers who have tried to work with loan providers are met with stiff resistance to negotiating alternative loan repayment terms.  While advocates for prohibiting student loans from being discharged in bankruptcy often cite fraud as the reason for the prohibition, the CFPB has found few, if any, instances of fraud.

In 2008, private student loans accounted for more than $20 billion in new issuances.  Since the change in the bankruptcy code, lenders have been more aggressive in bypassing schools’ financial aid offices and marketing loans directly to students.  Without the involvement and input of schools and financial aid officers in the loan process, school officials were unable to accurately assess and advise as to how much loans a student actually needed.  Furthermore, schools were unable to assess whether private loans (which often carry higher interest rates than government-backed loans) were appropriate for students.

Advocates will continue to push for student loan reform, both in issuance of loans and for making these loans dischargeable in bankruptcy.  While any change to the federal Bankruptcy Code will likely be slow and hard-fought, it is important for businesses and banks involved in loan issuance or servicing to note the continued push for reform and modification of the process.  Loan issuers and servicers need to continually monitor the political and regulatory environment to ensure they can appropriately adjust their business practices.

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