The Next “Bubble” – Student Loan Defaults
by Carron Nicks Armstrong
Finally, recovery from the recession appears to be gaining traction. There are signs of life in the housing industry, and unemployment is stabilizing. Pundits are warning, however, that another bubble is poised to burst.
The Consumer Financial Protection Bureau reports that student loan debt has topped $1,000,000,000,000 (that’s one trillion)—a 100 percent increase over just five years ago.
Let us put that in perspective. It equals the country’s budget deficit, exceeds the U.S. trade deficit by about 30 percent, and just about matches the amount of income tax the US Government collects each year. It outstrips personal credit card debt.
The average 2011 college graduate with student loans owed $25,000. While that amount is affordable for graduates who are able to find a job, an increasing number of students cannot pay their loans. Many students have much higher debt burdens, or are unable to earn adequate income. The Department of Education says 13.4 percent of student loans that entered repayment in 2008 have already defaulted. The Department expects that rate to rise to 16.5 percent over a 20-year loan repayment period. For loans expected to be issued in 2013, the President’s budget predicts a whopping 25 percent default rate.
Even for those students who timely make their payments, studies show that many are forced to delay or forgo buying cars and houses, starting families and planning for retirement. Indeed, with repayment terms of up to 30 years, more and more middle aged and retired Americans find themselves struggling to meet their student loan obligations.
Bankruptcy’s fresh start, once a last refuge for struggling former students, has been increasingly curtailed. Twenty-five years ago, the Second Circuit decided what has become the seminal case on student loan discharge, Brunner v. New York State Higher Educ. Servs. Corp., 831 F2d 395 (2nd Cir. 1987). Most circuits, including the Fifth Circuit, latched onto Brunneror a slightly modified version of it. The case remains a touchstone, even though the economy and the bankruptcy landscape have changed dramatically.
When Brunnerwas decided, federally-backed student loans were automatically discharged in a Chapter 7 case if they were more than five years old. If a debtor wanted to discharge student loans within the five year period, the Bankruptcy Code required that the debtor show that the loans caused “undue hardship.” The Brunner court required the debtor to show that the undue hardship would be continuing into the future. Since Brunner, the Code has been modified twice, first to extend the five year period to seven years, and then to completely eliminate any time period, making all student loans non-dischargeable unless they pose an undue hardship for an undefined period of time into the future.
Partial relief is available for loans backed by the federal government. Many students consolidate their loans, which lowers payments but extends the repayment period and increases interest costs. Some are able to take advantage of the Department of Education’s income-based repayment program. Also, borrowers who work in public service or government jobs may be able to have loans forgiven after ten years of payments.
Recognizing that student loan hardship is fast reaching crisis proportions, last year President Obama announced changes to the income-based repayment program that would allow federal loans to be paid at 10 percent of discretionary income with the balance forgiven after 20 years. That program, however, will be available only to borrowers who took out their first loans in 2008 or later.
None of these measures, though, address private student loans, which are not subject to federal student loan collection regulations. Consequently, few private loans offer forbearance, deferment, consolidation, or income contingent repayment programs comparable to government loans. Under the 2005 bankruptcy amendments, private student loans are also non-dischargeable. So far, legislation introduced in Congress to restore the discharge for private student loans has not generated serious consideration.
Consequently, consumer bankruptcy attorneys and bankruptcy courts can expect to see more and more debtors with significant student loan obligations that they are unable to pay in full.
Our society touts post-secondary education as a path to the American Dream and student loans as an investment in that future. Many believe that the confluence of rising tuition and easy credit will soon reach critical mass and that the bubble will burst, if it hasn’t already. How much drag that will place on an already fragile economy remains to be seen. In the meantime, wise consumer bankruptcy attorneys will master Brunnerand its progeny, as well as private and government student assistance programs, to adequately represent their debtor clients.
Carron Nicks Armstrong practices consumer bankruptcy law with Armstrong Kellett Bartholow P.C. Email comments to firstname.lastname@example.org.