Number One Student Loan To Avoid: The Private Student Loan
September 20, 2012

Okay, game time. Child support payments, alimony, debts related to tax liens, claims arising out of wrongful conduct, and both federal and private student loans. What do all of these things have in common? Answer: they all fall into the elite realm of non-dischargeable debts. That’s right, declaring bankruptcy will not absolve you of any of the above. Does anything stand out?

The qualities that make the above list so special are two-fold. Either the creditor did not have a choice in entering into the debtor-creditor relationship, like the child being born or someone getting hit by a drunk driver, or they are debts owed to the public, or both. Except, curiously enough, for private student loans. So why is this? Why don’t private student loans carry borrowers protections like other types of loans? The answer is a fuzzy one at best.

It’s tempting to ask, too, why federal student loans are non-dischargeable. To be fair, in 2005 it technically became possible to discharge any student loan. However, to do so requires that the borrower demonstrate “undue hardship,” which is extremely difficult and expensive to prove, as it involves hiring a lawyer and going to court, things that someone declaring bankruptcy can’t afford to do. The result is that student loans are basically immune to bankruptcy protection.

The concern when making a government debt dischargeable is that it could threaten the fiscal interest of the federal government. Take into account that as of June 2010, federal student debt outstanding was $665 billion, and that total student loan debt is increasing at a rate of about $2,853.88 per second, one can understand that concern. To mitigate this difficult situation for students, the government has put in place a number of alternatives to bankruptcy. Income-based repayment has been around since 2007 and offers very generously low monthly payments and dischargeability after 25 years. The trouble now is getting the word out on the emancipating capacity of student debt management.

Private student loans on the other hand, which are neither government debts nor involve a lack of creditor discretion, are void of basic consumer protections. It’s next to impossible to discharge any student loan in bankruptcy and the bankruptcy alternatives available to borrowers with federal student loans do not apply to those with private student loans. Bankrupt individuals with outstanding PLSs are left virtually optionless.

A number of sources have recently pointed out the unscrupulous lack of borrowers protections for private student loans, most notably the Consumer Financial Protection Bureau, whose August 2012 report recommends increased accessibility to bankruptcy protections for PLSs. The Bureau also notes a curious lack of documentation supporting the rationale for placing private student loans in this rather nebulous non-category. Students need to be aware that sticking with federal student loans might spare them a lot of grief.