How Not to Deal with the Private Student Loan Problem

Until passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), private student loans were treated as ordinary unsecured consumer debt.  That badly misnamed piece of legislation  made private education loans nondischargeable in bankruptcy except in cases of undue hardship.

Several measures to relieve private student loan debtors have been introduced in Congress in the last two years, but none has been enacted. One measure, S 1541 also called the private Student Loan Debt Swap Act of 2009, looks like an attempt to relieve debtors.  When analyzed closely this bill proves to be more about bailing out lenders than helping students.  It would allow students to refinance private student loans under the Federal Direct Loan Program under the same terms as consolidation loans.

Unfortunately, the proposed legislation would only be available if  the student had been eligible for an unsubsidized Stafford Loan under the Federal Family Education Loan Program (FFEL) when the debt was incurred, and did not exceed debt ceilings established for that progran.  If enacted, the borrower would benefit from a lower interest rate and more flexible repayment terms but would now have the entire debt collection arsenal of the Federal Government arrayed against her.

In the unlikely event Congress restores bankruptcy protection for private student loan debtors, this debtor would be out of luck, while the lender would have collected its full claim from the Federal Government.  As the bill is written, it applies mainly to people who never worked with the financial aid office of a reputable educational institution and were steered directly into private loan arrangements with unfavorable terms.

It would not apply to the much larger body of debtors who resorted to private loans after exceeding FFEL limits, to cosigners (mainly parents), or to people who enrolled in programs that did not qualify for FFELP but are nonetheless considered to have educational loans for purposes of the bankruptcy laws.  In short, it does essentially nothing for struggling debtors, since, even for those who qualify for refinancing, reducing interest rates and extending the repayment period will fail to make many obligations affordable.

Check that Lender’s Arithmetic!

The problem of the debt which ought to have been liquidated according to the terms of a Chapter 13 plan, but surfaces with a vengeance due to undisclosed fees and lender accounting shenanigans, is familiar in mortgage contexts but may also involve student loans, as the recent case of Carlson-Callow v. Sallie Mae Servicing, Educational Credit Management Corporation, and Northwest Loan Association (U.S. Bankr. Idaho, 2008 Bankr. Lexis 1815) illustrates.

On first reading this looks like one of those rare instances where a debtor obtained real relief from an onerous student loan. The debtor, 60 years old and suffering from a serious congenital disorder likely to progressively limit her ability to work full time in an indifferently-paid profession, owed $88,776 in 2001, when she consolidated all her loans, and $123,070 in 2005, because of interest accruing during forbearance. The creditors had already agreed to settle for the original principal and reduce the interest rate to 5%, but this did not result in an affordable repayment amount.

After scrutinizing the debtor’s budget, disallowing minimal support to an adult daughter, and putting the last nail in the coffin of an unprofitable business, the court concluded the debtor could currently afford to pay $447/month toward her student loans.  The court then discharged all but $37,500 of the debt on grounds of undue hardship, maintaining that that amount could be paid off over five years on a graduated payment plan rising to $672 in the final 32 months of the plan.  The graduated payment took into account that other debts would be paid off earlier; it did not take into account the debtor’s deteriorating health.

The monthly amount required to fully amortize a $37,500 debt over five years at 5% interest is $707.  The payment schedule as entered into the court record leaves an undischargeable debt of $9,252.78, assuming the debtor is able to make all payments as scheduled. Something doesn’t add up here.  It looks as if this is one more area in which attorneys are going to have to go through all the documents with a fine-toothed comb, checking all the figures, to make sure their clients are getting the relief they are being told to expect.