Student loan debt in the United State has risen to $1.6 trillion dollars, second only to mortgages as the highest category of consumer debt in the United States. While new loans account for some of the increase, that’s only part of the story. One of the more obscure reasons for the explosion of student loan debt is found in the fine print. Many federal and private student loans will add accrued interest to principal beginning on the date of disbursement and continuing through years of schooling and during any forbearance periods. The addition of interest to amount borrowed, causes the loan balance to snowball as borrowers end up paying interest on interest. While the Truth in Lending Act was designed to require disclosures of capitalized interest, it does not apply to federal student loans and private student lenders have become quite adept at making this problem less than obvious.
In a perfect world, college graduates will earn enough to pay the exorbitant cost of an American education, but it’s common for there to be a financial hiccup over the long life of a student loan, particularly for private student loans that don’t offer affordable repayment plans. This is the most common phone call I receive. The refusal of private student lenders to work with borrowers is also one of the principal complaints received by the Consumer Financial Protection Bureau. One borrower told me his private student loan servicer demanded $2500 per month despite informing them his take home pay was $2500 per month. With all the special protections accorded student loans under the law, there is little incentive for a private student loan servicer to care whether a borrower can afford the payment or not. Some solve this problem by living with a parent or significant other who will pay living expenses so they can afford to make their student loan payments. Most of course don’t have that luxury. Another private student loan borrower complained that after $20,173 in payments over several years, she owed $14,000 more than she had borrowed. The difference was entirely attributable to the capitalized interest that accrued when she couldn’t make a full payment. While federal loans offer Income Driven Repayment Plans (“IDR”), the payment will often lead to unpaid interest, a danger for those in careers where income might rise sharply within a 25 year IDR repayment period. As a fledgling graduate starts earning more serious money, an IDR payment can jump so high it is no longer feasible.
Some critics have commented on how the student loan bubble is having a dampening effect on the economy. That rings true as I’ve had several callers in their 40s complain they’ll never own a home because they don’t see themselves ever escaping their student loan prison. That’s ironic given it was the 2008 recession that forced the government into pressuring mortgage companies to offer loan modifications to help homeowners behind in their payments. Private student loan debt is being bundled together and sold to investors, much like mortgage backed securities, the same investment model which contributed to the economic collapse in 2008. While mortgage companies have an incentive to work with borrowers to lessen their foreclosure portfolios, the student loan industry follows a collection model that uses the inability to pay as an opportunity to assess collection fees of up to 18% and capitalize unpaid interest on a yearly or even quarterly basis during a forbearance. Strategic default is something private student loan borrowers are forced to consider. It’s not that borrowers don’t want to repay their student loans. It’s just that between the ridiculous cost of a college education in modern day America, and all the protections accorded student lenders under American law, the ability of a borrower to escape the inexorable pull of student loan debt can be akin to escaping a black hole.
The lack of a level playing field has encouraged many businesses to regard student loans as a good investment opportunity. I attended a free student loan webinar entitled “Student Loans: The Next Big Thing for the Collection Industry.” I’m not a collection lawyer but I wanted to see what collection companies were saying about my student loan clients. I submitted a written question during the webinar asking what percentage of student loans face a discharge in bankruptcy and received this response – “bankruptcy discharges of student loans are the unicorn of the bankruptcy world.” I thought it telling a student loan collector would compare the discharge of student loans in bankruptcy to a mythical creature no one ever sees.
The Department of Education continues to take extreme positions when borrowers ask for an undue hardship discharge, claiming its IDR plans in essence preempt the undue hardship provisions in 11 USC 523(a)(8), arguing a borrower can never prove an undue hardship if they are offered an affordable repayment plan. An increasing number of courts have rejected this position and the Department of Education recently asked for comments on its position, ostensibly with an eye toward making them less harsh. Informed observers are not expecting any meaningful change in how zealously the Department of Education pursues student loan borrowers who try to discharge their loans in bankruptcy. At best, federal loans offer borrowers the opportunity to stay on the treadmill for up to 25 years, while private loans often don’t offer any realistic opportunity for ever escaping.
To mI don’t believe the unicorn characterization is accurate but this message is one the student loan industry would like borrowers to believe is true. Undue hardship complaints may be fact specific but I’ve used that process to help one debtor get rid of $300,000 in federal and private student loans. Courts are increasingly abandoning the harsh Brunner standard and adopting a more flexible totality of the circumstances test. Although the First Circuit has successfully avoided adopting any particular test, most First Circuit trial courts and the First Circuit Bankruptcy Appellate Panel have adopted the totality of the circumstances test. I’ve used the Proof of Claim procedure in a chapter 13 bankruptcy to avoid $150,000 in private student loans when a husband discovered his soon to be ex-wife had forged his name to their children’s student loans. One cutting edge issue in bankruptcy and student loans is the possibility of automatically discharging a student loan like a credit card if it doesn’t meet the definition of a “qualified education loan” in Section 523(a)(8). There is a class action case in Texas against Navient where Navient was accused of collecting on private student loan debt that had been discharged in a bankruptcy. In 2017, Transworld Systems, the servicer for National Collegiate Student Loan Trust (“NCSLT”) loans, entered into a consent order with the Consumer Financial Protection Bureau agreeing that its documentation can be inadequate and its affidavits alleging personal knowledge fraudulent. I’ve dismissed several cases filed by some private student lenders like NCSLT because of its inability to prove it owned the securitized student loans. NCSLT and other entities with an interest in the trusts, however, have succeeded in convincing one court the order is not binding on them and the wrangling continues. The law governing student loan debt is tilted strongly in favor of student lenders. This forces student loan lawyers to become creative in trying to find a way to level the playing field. I can often discharge IRS debt in bankruptcy after three years, but the law excepts student loan debt from discharge with few exceptions. The options available to student loan borrowers under current law are just not enough. In my opinion, some fundamental shift in how we as a society view student loan debt has to happen before these borrowers can return to the economy. This isn’t a problem that is just going away.