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Student Borrowers Could Shed Loans With Proposed Law

Thousands of heavily indebted college graduates could shed some student loans with the help of bankruptcy courts if a group of legislators have their way.

Bills were introduced in both the House and Senate last week that would treat private student loans like other unsecured debt, such as credit card balances, allowing insolvent borrowers to discharge these debts in bankruptcy.

All student loans -- private and public alike -- currently are treated like tax debts and unpaid child support, which can erased in bankruptcy only in the most dire circumstances. Under the new proposals, federally-guaranteed student loans -- the type issued with government (in other words, "taxpayer") backing -- would continue to be difficult to erase. But private student loans, which have no government backing nor federally-mandated protections for borrowers, would not.

Advocates say the change would bring the market back to where it was before 2005, when a provision protecting private student lenders was quietly slipped into the bankruptcy reform bill, without review or discussion.

Unlike federally-guaranteed student loans, which are issued with preferential interest rates and terms, private loans often come with sky-high variable-rates and fees. Worse, an investigation done by the Los Angeles Times found that the costs were often not disclosed to borrowers prior to the funding, causing Rep. George Miller (D-Calif.) to liken them to predatory sub-prime mortgages.

"Sadly, our nation's bankruptcy laws are another example of how lenders' well-heeled lobbyists successfully gamed the system and won special treatment, at the expense of millions of Americans working hard to pay back their college debt," said Miller in a statement supporting the bill.

Added Steve Cohen (D-Tenn.) sponsor of the The Private Student Loan Bankruptcy Fairness Act (HR 5043): "People who seek higher education to better their futures should not be dissuaded from doing so by the threat of financial ruin."

In the past, lenders have argued that they needed the bankruptcy ban because students emerging from college are almost always insolvent, with far more debts than assets. Yet lenders finance education believing that the "security" for their loan is the increased earnings that the student will enjoy over time. If they're able to file bankruptcy shortly after graduation, they could shed their debts before that education had a chance to pay off.

Graduates, on the other hand, maintain that they often had no idea that the private loans they'd secured in college were not the safe, federally-issued type, because lenders rarely pointed out the differences to their naive borrowers, only barely old enough to sign legally-binding contracts.

The ignorance of borrowers to the differences are further underscored by statistics showing that students often got private loans before they had maxed-out their eligibility for the safer and cheaper federally-guaranteed loans. Without protection from this risk, lenders would be reluctant to issue the loans and would demand higher rates of interest, they said.

Lauren Asher, president of the Institute for College Access & Success, said loan statistics belie that argument. Private student loan rates did not decline after the bankruptcy protections were added, but fewer loans were made.

"Bankruptcy is something that people do as a last resort," Asher said. "There is a myth of the student who graduates and just decides they don't want to pay their loan."

Meanwhile, thousands of indebted graduates say the interest and fees on these loans often mount so fast and furiously that there's little hope that they'll pay the loans in their lifetime, much less a few years after graduation. That's convinced more than two-dozen organizations, ranging from Consumers Union to the American Council on Education, to throw their support behind the legislation.

If you're one of those students, Asher suggests that you do too and write your Congressman. The Project on Student Debt has a standard email message that you can send directly from their site to make it easy.

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