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Congress Considers New Bankruptcy Rules on Private College Loans

A possible fight over college loans is looming in Congress, but not over the maximum a student can borrow.  Instead, members of both the House and Senate have introduced bills that would allow private bank college loans to be dismissed in bankruptcy proceedings.

Although federal college loans and federally backed bank loans long have been exempt from dismissal in bankruptcy actions except in extreme circumstances, the largely unregulated private bank loans – most often used to finance attendance at for-profit colleges – were given the same no-discharge status in bankruptcy legislation passed in 2005.

“The high interest rate on private student loans have made them incredibly profitable for loan companies and saddled students with crushing debt,” Sen. Richard Durbin (D-Ill.) said when he and others introduced identical versions of the Private Student Loan Bankruptcy Fairness Act of 2010 in the House and Senate in April.

At a hearing on the matter the same month, Valisha Cooks, who borrowed to attend the for-profit online University of Phoenix, said after graduation her loans seemed to take on a life of their own.

Cooks graduated with about $41,000 in federal loans and $36,000 in private loans — $30,000 of which, a University of Phoenix official said, were for her education there. Three years later, however, she said the lender for her private loans tacked more than $16,000 to her principal balance, which she says now stands at $53,000.

“I assumed that I would be better off with a college degree,” Cooks testified at the hearing. “But after college my loan payments were $1,150 a month, $750 of which was for the private loans,” Cooks testified. “That amounts to more than half of my take home pay,”

Cooks said she filed for bankruptcy, but that only resolved about $10,000 in debt.

“Now, even though I have a good job, I can’t afford to pay all my bills in any one month,” said Cooks, who works at the University of California Los Angeles as an education coordinator. “I go to food banks to feed my son, and I will never be able to buy a house.”

Proponents of the legislation say it’s a safety net for student loan borrowers who find themselves unable to pay off their student loans.

“It’s just common sense to have a safety net for people who get into really difficult situations,” Edie Irons, spokeswoman for the California-based Project on Student Debt, told Youth Today.

“We provide bankruptcy protection for gambling debt and credit card debt and other types of consumer credit,” Irons said. “Especially in a recession, it’s an important tool to clear out bad debt that’s probably not going to be paid back and allow people to move forward with their lives.”

But opponents of the legislation say it puts the private student loan industry at undue risk with borrowers who at the time of taking out the loan generally have no job and little else to lose. Further, he said it may induce students to file for bankruptcy in order to avoid payment, not realizing that bankruptcy has consequences of its own.

A total of 136,142 consumer bankruptcies were filed nationwide in May — a 9 percent increase over the 124,838 that were filed in May 2009, according to the American Bankruptcy Institute.

“Students are smart but relatively immature consumers of very expensive goods and services, like a college education,” John Hupalo, managing director at  Samuel A. Ramirez & Co., Inc., a New York-based investment firm, testified during the same Congressional hearing.

Some young graduates, he said, might figure: “With no assets to lose, an education in hand, why not discharge the loan without ever making a payment to the lender?

“I fear that borrowers just out of school would discount other risks and be saddled with unintended consequences potentially hampering their ability to buy furniture or a car or their first home on credit a few short years after the discharge,” Hupalo said.

Irons, of the Project on Student Debt, dismissed the idea that allowing the private student loans to be dismissed through bankruptcy court would lead more young graduates to file for bankruptcy.

“Bankruptcy is a painful choice and we don’t expect people to make it unnecessarily,” Irons said.

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