Once again, student-loan season is upon us. As a new class of freshmen ships off for a hopeful first year of college or trade school, many are as busy figuring out financial arrangements as lining up classes. It wasn’t always this way, but as education has become both more costly and more necessary, many students feel they don’t have any other choice. And so they borrow $10,000, $25,000, as much as $100,000, often unaware of the unforgiving nature of the debt they’re taking on.
This year, as these students prepare to sign away their futures, they would do well to consider a report released by the Consumer Financial Protection Bureau (CFPB). On July 20, the agency designed by Massachusetts Senate candidate Elizabeth Warren released “Private Student Loans,” a devastating expose of the $150 billion private student loan industry, one of the banking world’s Goliaths. The report is both an official account of private lenders’ underhanded “subprime-style” tactics as well as a sharp warning against taking out private loans that put students at risk of financial ruin.
As described in the report, the student-loan industry is a villainous enterprise, set on scamming some of the country’s most eager and vulnerable citizens. Anchored by lending giants like Sallie Mae and bolstered by some for-profit colleges that lend to their own students, it bears all the hallmarks of some of the last decade’s other most predatory industries. Much like the mortgage industry, it used cheap-credit tactics to prey on low-information borrowers, typically students of color, effectively quadrupling in size between 2001 and 2008. And like the mortgage industry, it collapsed in the recession, leaving many students drowning in debt. Today, more than $8.1 billion worth of private student loans are in default.
Here’s one way the industry goes about its business: though private student loans typically come to students through a menu of lending options from a college or university’s financial aid office, along with federal options like Pell grants and subsidized Stafford loans, the CFPB report explains that many of these loans are offered directly to students without input from a financial aid office. This tactic, called “direct to consumer” lending, results in “significant over-borrowing.” This is problematic because “over-borrowing increases the likelihood of default, to the detriment of both borrower and lender.”
And the scam gets worse. Though an estimated two-thirds of private student-loan borrowers don’t understand the difference between private and federal loans, there is at least one critical difference: private student loans lack key protections that come with federal student loans—most notably, a variety of options for delaying or reducing payments if students encounter economic hardship.
“That confusion has been deliberate,” said Lauren Asher, president of the Institute for College Access and Success. “People get stuck with these loans, often without clear information.”
The worst part of private student loans is that when students have run out of all other options and need to declare bankruptcy, they can’t. (The one exception to this rule is when students can prove an “undue hardship,” but this standard is nearly impossible to meet, and an analysis by a bankruptcy lawyer organization found that those who qualify are “very close to the poverty level with little or no hope for improvement.”)
Consider the case of Fred, a student whose story was highlighted by Jennifer Mishory, the deputy director of the youth advocacy group Young Invincibles, in her testimony before the Senate Banking Subcommittee on Financial Institutions and Consumer Protection in late July (the hearing took place just after the CFPB report was released). Fred was a victim of a violent crime in which he sustained “injuries to his face and head.” Because he was uninsured, he quickly found himself buried by medical expenses and ended up having to declare bankruptcy. While bankruptcy helped Fred clear his medical debts, under the perverse terms of bankruptcy law, he couldn’t get any reprieve from his student loans. Fred left the bankruptcy proceedings with $51,000 in student debt.
Strangely, had Fred filed for bankruptcy before 2005, he wouldn’t have this problem. A little-noticed change to bankruptcy law that year put private student loans into the category of non-dischargeable debt, or debt that can’t be cleared away through bankruptcy. The CFPB report says that this type of debt includes “child support payments, alimony, debts related to tax liens, claims arising out of wrongful conduct (like a judgment against a drunk driver), and both federal and private student loans.”
And yet, it’s not entirely clear why or how private student loans came to be included in this category of debt. While all the other forms of bankruptcy-proof debt are either “owed to the public or the creditor lacks discretion over entering into the debtor-creditor relationship (or both),” private loans don’t fit either requirement, according to the CFPB report. Moreover, the actual number of student bankruptcies is relatively small, and a 1997 review found no evidence of systemic abuse in student-loan bankruptcy claims.
So how did private loans come to be shoehorned in with all the other forms of non-dischargeable debt?
The CFPB report notes that the Congressional record has little to offer “regarding the rationale for treating private student loans similarly to federal student loans and differently from general consumer loans.” What we do know is that the change came along with a laundry list of other changes to bankruptcy law, and that Sallie Mae, the biggest private lender, spent over $1.4 million on lobbying that year. That number has dramatically increased, with the company spending between $3 million and $4 million a year from 2007 to 2011.
Still, there is a faint glimmer of hope. Two bills seek to reverse the 2005 bankruptcy-law change: Illinois Senator Dick Durbin’s Fairness for Struggling Students Act and Tennessee Congressman Steve Cohen’s Private Student Loan Bankruptcy Fairness Act. Both bills would push private student loans back into the category of debt that is dischargeable in bankruptcy, giving students who are too deep in debt a second chance.
Reversing the 2005 change “could potentially be a really big deal for people who are struggling,” Mishory said.
Remarkably, Sallie Mae, which engaged in highly predatory practices throughout the last decade, has endorsed this change. But the truth is that both bills still have a long distance to travel before they become law. As much as they could offer real relief to those new students who are about to sign on the dotted line to pay for their degrees, it’s unlikely that Congress will make this a priority, given that it can’t even get its annual budgeting bills off the ground.
Where does that leave incoming college students? For one thing, they would do well to make the CFPB report their first reading assignment. At the very least, they should think of private student loans as a last resort.
Editor’s Note: An earlier version of this story incorrectly stated that Rep. Cohen’s bill would only provide bankruptcy protection for new private student loans. The legislation would actually cover all private student loans—including existing ones.