The National Association of Student
Financial Aid Administrators originally published this article. I am grateful to them for allowing me to
reprint it here.
The original link for the article is here.
Seven Ways to Provide Student Loan Debt Relief
The current generation of
students is leaving school with more debt than any previous generation. While
postsecondary education remains a good investment for the average student loan
borrower, some borrowers will never be able to repay their student loans in
full. Moreover, current bankruptcy law and procedures make it very difficult
for borrowers with student debt to ever obtain a fresh financial start.
At the federal level, there is
some interest in policies that might alleviate student loan debt burdens. The
desire to provide student debt relief to borrowers is tempered by concern about
the cost to taxpayers when this government guaranteed debt isn’t fully repaid.
In my view, it is possible to provide a modest level of student debt relief to borrowers
without imposing substantial costs on taxpayers. This could be accomplished by modifying
the Income Based Replacement (IBR) Loan Program and through changes to the
bankruptcy code.
The IBR program,
enacted in 2009, provides four benefits to student loan borrowers.
1. Reduction in
student loan payments when household income is low in relation to qualified
student debt,
2. Reduction in interest
payments when IBR payments do not cover interest due,
3. Limits on the
capitalization of interest for loans in deferment or forbearance, and
4. Forgiveness of a
remaining loan balance 25 years after the student loan enters repayment.
In addition, some
student loan borrowers who maintain payments through the IBR program will be
able to utilize public loan forgiveness programs
The primary purpose of the IBR program is to prevent borrowers
from defaulting on their student loan when their household income is low
compared to qualified student loan debt. Only student loan borrowers with
chronically low levels of household income can receive some debt forgiveness. Borrowers
who receive lower payments through the IBR program will often pay more on their
loan than if they remain in the standard 10-year payment plan.
The IBR program is
complex and does not offer assistance to many overextended student loan borrowers.
First, the IBR program does not cover PLUS loans made to parents, private
loans, or consolidated loans that include a parent PLUS loan or a private
student loan. The decision to consolidate 10-year loans into a 20-year loan
could also make borrowers ineligible for the IBR program. To fully benefit from
the IBR program, borrowers need to be
aware of IBR rules long before they are aware that they will need IBR, when
they are borrowing or consolidating federal student loans.
Second, the IBR
program often provides little or no relief to a household that has high levels
of both consumer debt and student loans. The IBR program is especially complex
for married households. A single person
who qualifies for the reduced IBR loan payment could lose this benefit if he or
she marries someone with high levels of consumer debt, even if household
debt-to-income ratios increased after marriage. Married individuals could
choose to file separate tax returns to take advantage of the IBR program, but
that decision usually results in a larger tax obligation.
It is impossible to
modify the IBR program to account for consumer debt without creating an
incentive for additional borrowing. Borrowers
with high levels of student debt and consumer loans might seek relief in
bankruptcy courts. However, current
bankruptcy laws and procedures offer little relief for borrowers with student
loan debt.
There are two ways
debtors can seek student loan debt relief in bankruptcy. First, the debtor
could petition the court for a complete or partial discharge of student debt.
Second, in a Chapter 13 bankruptcy the debtor could petition the court for a
payment plan that favors the repayment of student loans over the repayment of
other unsecured loans. Neither remedy is easily obtained.
To discharge
student debt in bankruptcy, the borrower must prove that he or she has an
“undue hardship.” Most courts require that the borrower show a “certainty of
hopelessness” for his or her financial situation over the repayment term of the
loan. A certainty for hopelessness is extremely difficult to demonstrate
because there is some probability circumstances will improve, even for
individuals in extremely dire circumstances. An August 31, 2012, New
York Times article describing the
petition of a legally blind, unemployed man illustrated the hurdles a student
loan borrower must clear in order to have student debt discharged in
bankruptcy.
Any proposal that
makes it easy to discharge government guaranteed student loans in bankruptcy
entails some additional cost to the taxpayer. However, it is easy to envision a
less stringent student loan discharge rule that does not significantly increase
taxpayer costs. Such a rule would rely on objective criteria rather than the
subjective “undue hardship” concept. For example, student loan discharge could
be limited to individuals with incomes near poverty level, contingent on
participation in the IBR program, favor individuals with medical problems, and
allow for partial, rather than full, loan cancellation.
Two other aspects of the
bankruptcy code have a substantial impact on financial outcomes for student loan
borrowers in bankruptcy and for the government agencies that hold or guarantee
student debt. First, financial outcomes
are affected by the rules governing whether a debtor can obtain a Chapter 7
bankruptcy or a Chapter 13 bankruptcy. Second,
financial outcomes are affected by the rules governing repayment of student
debt and other unsecured consumer loans under a Chapter 13 repayment plan.
Under a Chapter 7 bankruptcy, the
bankruptcy court will immediately discharge most unsecured consumer loans. In a
Chapter 13 bankruptcy plan, debtors must file repayment plans with the bankruptcy
court. The repayment plan determines how much debtors can repay creditors and
the amount received by each creditor. Prior to the 2005 bankruptcy law, debtors
could choose to either file under Chapter 7 or Chapter 13. The 2005 bankruptcy
law created a means test that required many individuals with incomes over the
household median to file Chapter 13 rather than Chapter 7.
When student loans are dismissed
under Chapter 7 bankruptcy, the borrower gets an immediate fresh start and can
use all the newly available funds for the repayment of student debt. A borrower
who obtained a deferment prior to bankruptcy can immediately renew payments on
his or her student loan. By contrast, when borrowers are placed into a Chapter
13 repayment plan, the amount allocated to the payment of student loans might
not even cover interest and, in many circumstances, the debtor will leave
bankruptcy with a substantial student debt intact.
Student loan borrowers in Chapter
13 can petition the bankruptcy court to allocate a greater amount of their
payment plan to the repayment of student loans and a lower amount to the
repayment of other unsecured credit card debt. However, most courts tend to
favor a payment plan that does not discriminate against any class of unsecured
creditors. As a result, many student loan debtors emerge from the bankruptcy
process five years older with a substantial amount of unpaid student loans.
Many individuals experience decreases in income and have fewer job prospects
after age 50. A delay in repayment of student loans caused by a forced entry
into a Chapter 7 bankruptcy plan will increase financial exposure to taxpayers,
increase student loan default rates, and decrease collection rates.
A revision of Chapter 13
bankruptcy rules that gives priority to student debt payments over other
unsecured debt payments in bankruptcy would provide student loan debtors with a
fresh financial start and would ultimately reduce taxpayer losses. Unsecured
creditors would still enjoy greater collection rights than existed prior to the
2005 bankruptcy law.
Under current law,
very little debt relief is offered to overextended student loan borrowers
experiencing substantial economic hardship. Several policy changes might
provide modest debt relief to these borrowers, maintain strong incentives
against default, and protect taxpayer interests. These policies include:
· Allowing married couples to
obtain IBR debt reduction without having to actually file separate tax returns,
· Making PLUS loans to parents and
consolidated student loans with a PLUS loan eligible for the IBR loan program,
· Allowing private student loans to
be discharged in bankruptcy,
· Basing the decision to discharge
student loans in bankruptcy on objective criteria pertaining to the economic
status of the bankruptcy applicant rather than the subjective “undue
hardship” concept,
· Allowing for quicker loan
forgiveness under the IBR program for individuals in dire economic
circumstances,
· Repealing or modify the Chapter
13 means test,
· Providing priority to student
debt over other unsecured loans in Chapter 13.
The goal of debt
forgiveness policies inside and outside of bankruptcy is to balance two
competing objectives: providing overextended borrowers a fresh start, and fair
treatment towards creditors. The pendulum may have swung too close to the
creditor, especially with regard to the treatment of student debt.
The author is a retired economist who worked in
the Office of Economic Policy of the U.S. Treasury from 1988 to 2012. He
publishes a blog www.economicmemos.com
