Loans Organized Crime Might Envy, Part 2
NEW YORK (MainStreet) As we said in Part 1, the terms for lending money to college students for their tuition are such that they would make loan sharks green with envy. One aspect of these loans that make them very attractive to private lenders is the near impossibility of them being discharged in bankruptcy.
"They are almost guaranteed to be collected, so it is easy to sell the notes," said Barmak Nassirian, formerly an official with the American Association of Collegiate Registrars and Admissions Officers.
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More bluntly, Clare Law, a certified educational planner, summed it up this way: "The point that student loans are not dischargeable is huge."
Even the Consumer Financial Protection Bureau (CFPB) has raised concerns about the bankruptcy provision. The CFPB said, "Because student loans are not generally dischargeable in bankruptcy, and because federal student loans have specific consumer protections guaranteed by law, it is very important for borrowers to understand their rights and responsibilities."
Richard Cordray, the Director of the CFPB, wants Congress to evaluate the "appropriateness of the bankruptcy discharge standard."
Secretary of Education Arne Duncan asks that Congress require institutions of higher education and private education lenders to work with the Department of Education and the CFPB to provide "relief to private student loan borrowers who are experiencing financial distress."
One CFPB proposal is for borrowers to look at employment prospects after graduation. They think this may be a way to ease financial distress. "It may be reasonable to assume that future repayment ability is related to whether a postsecondary education program adequately prepares a student for gainful employment," the CFPB said.
However, there are some statistics that may be correlated with the value of a degree from a particular school.
But Law counters, "Colleges don't say to a student majoring in photography or nursing. Only 10% of your future wages should go to pay your student loans so now you are over that limit."
She added that parents and students ordinarily do not know what their monthly payments will be. She also believes that paying for college is about a 14-year repayment commitment. She mentioned that the standard repayment plan is ten years and some "income-based" repayment plans stretch that over 25 years.
Christopher Chaplin and Cheryl Browning, certified college planning advisers for the consumer credit counseling service Clarifi in Philadelphia, confirm what Law said.
"Parents are not conscious of the process," they said. "It is such an emotional experience."
Law affirms what Chaplin and Browning say.
According to her, financial institutions think there is little risk lending to college students.
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"I think it is because the financial institutions feel that you could not go wrong with loaning money to parents who were buying a slice of the American dream," she said.
Law noted that students who default soon after graduation usually have no assets. While this complicates matters for the lender - and it is even more so for the student it means nothing to the colleges.
"If parents and students couldn't borrow, if borrowers' viability was more carefully checked, college enrollments would fall through the floor," Law asserted.
Bankruptcy and the Origin of this State of Affairs
Mark Kantrowitz, a nationally recognized expert in the financing of college educations and the publisher of Edvisors NEtwork, provided insight into why student loans are not included in bankruptcies.
"Prior to 1976 education loans were dischargeable. Then the U.S. Bankruptcy Code in 1978 established an exception to discharge for five years (except in cases of undue hardship) for loans made by the government or colleges," Kantrowitz explained. "Then in 1979 an amendment used language of loans made by "a non-profit institution of higher education."
The Bankruptcy Amendments and Federal Judgeship Act of 1984 struck the words "of higher education" from this language, opening the door for private student loans to be excepted from discharge if a nonprofit institution were involved in making the loans. This continued through 2005, when the Bankruptcy Abuse and Consumer Protection Act of 2005 added a new exception for "qualified education loans", which includes private student loans even without nonprofit involvement."
Kantrowitz believes that the reason students loans were prohibited from being discharged in bankruptcy is lobbying by the lenders. He said that there was a lot of concern about moral hazard meaning students would be encouraged to discharge loans in bankruptcy after graduation absent this prohibition.
"There was no evidence of this," said Kantrowitz. "Bankruptcies were about one percent of student loans."
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He also said that, after the fact, when lenders and politicians were criticized for the bankruptcy prohibition, there were some arguments made along the lines that lenders would not participate without the bankruptcy provision. But Kantrowitz does not feel this rationale is valid.
Another educational planner, Gary Carpenter, owner of College Planning Services, believes the prohibition sweetens an already sweet pot.
"They are looking at it as a young person who will graduate and they will be earning an affluent income and they will repay the loan," said Carpenter. "Then there are services they can offer such as credit cards, investments, checking accounts and retire programs. Plus there is the additional guarantee of a cosigner and that the loans are not dischargeable in bankruptcy."
Whether it is a scandal or not one thing is certain: lenders of student financial aid possess powerful tools to ensure the debt is repaid. There is the "slice of the American dream" motivating parents to repay if their kids cannot - and there is the fact this is not a loan one can just walk away from like a mortgage or credit card debt.
Law, the educational planner, cautions prospective borrowers. "The caveat remains," she said. "Don't take out loans you can't repay."
--Written by Michael P. Tremoglie for MainStreet