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.