Having a bankruptcy flagged in your credit file can make obtaining a credit card, taking out a car loan or applying for a home mortgage a nonstarter for years. It can also affect your ability to land a job.
Yet in a move that’s certain to be scrutinized, the Obama administration is weighing whether to loosen bankruptcy laws so some borrowers drowning in student loan debt could unload those burdens and start fresh.
The proposal is included in a recently unveiled White House initiative called the Student Aid Bill of Rights, which is aimed at providing more protections for federal student loan borrowers.
The initiatives, including a new online outlet for filing loan complaints, come amid growing concerns about the debt that college students are carrying after graduating. The average amount of student loan debt for 2013 college graduates was $28,400.
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Unlike most debts, federal law prohibits student loans from government and private lenders from being forgiven in bankruptcy proceedings, except in cases of undue hardship. Even in those rare situations — and there are fewer than 1,000 people a year trying to get rid of student loans through the courts — a bankruptcy action can be expensive and cumbersome.
But the Student Aid Bill of Rights directs government officials to explore the possible expansion of bankruptcy options on federal student loans. No details have been released.
Why has the idea been floated?
“To make sure that more and more young people can afford to go to college and then afterward aren’t so burdened with debt that you can’t do anything else,” President Barack Obama said in a speech earlier this month at Georgia Tech University, where he unveiled the proposal.
Any bankruptcy law changes would have to be approved by the Republican-controlled Congress, so substantial pushback is likely.
One possible scenario, according to financial aid experts, is to allow borrowers with private student loans from financial institutions to take bankruptcy.
That’s a small subset — only about 10 percent of student loans are made by private lenders, according to the Credit Karma online financial services firm.
Given that bankruptcy can be one of the most negative items pinned to your credit report for as long as 10 years, why make it easier to enter the system, even as a last resort? What’s the incentive to fight to stay current on student loans if the problem can be wiped out in one fell swoop?
Better for former students to focus on a host of flexible repayment options and even loan forgiveness programs that have been expanded in recent years. Also, don’t forget that many credit counseling services provide free loan restructuring advice.
Other aspects of the new Student Aid Bill of Rights plan could ease the pressure on student loan borrowers and clamp down on lending industry repayment practices.
For example, the plan directs the U.S. Department of Education to create a website by July 1, 2016, so borrowers with federal student loans can file complaints about lenders, servicing companies, collection agencies, and colleges and universities.
Another benefit of the new program applies to borrowers who make higher monthly payments than required. Under the plan, the loan servicer will have to apply the extra funds to the student loan with the highest interest rate, unless directed otherwise by the borrower.
There’s another way to deal with all this student debt — one that gets lost in the policy debates.
It starts long before the kids head to college and involves a family discussion about money — the cost of attending college, the importance of picking schools that are not financial stretches, zeroing in on a degree that balances with the cost of education and understanding that paying back debts even a little at a time requires commitment.