Will private student loans become dischargeable in bankruptcy?

One of the more pressing issues in the area of consumer debt is that of student loans. Many recent graduates in Illinois and around the country find themselves buried beneath tens--or sometimes thousands--of dollars in debt. And with the current economic woes that have left many young people unemployed or underemployed, paying off these loans can seem like a Herculean task.

As many students know, loans taken out to pay for their education cannot be discharged through bankruptcy. But that was not always the case. Decades ago, the Bankruptcy Code viewed student loans like certain other debts and provided that they would be discharged once the bankruptcy process was completed. But a series of revisions to the Code, culminating in a 2005 law change, rendered educational loans, whether federal or private, non-dischargeable unless borrowers can prove they meet the very difficult "undue hardship" test.

There have been recent suggestions that the law should be changed again, this time to allow private loans to be discharged in bankruptcy, according to a report issued by the Consumer Financial Protection Bureau. The reason is that private lenders do not offer struggling borrowers the option to select flexible repayment terms. Federally-backed loans, by contrast, give students the ability to make payments based on how much money they are currently earning.

In addition, one man who provides information on educational loans noted that the change would create a potentially beneficial incentive structure. Faced with the possibility that they could receive nothing in bankruptcy, some private lenders might begin to offer borrowers flexible repayment terms.

It is unknown what action Congress will take on this issue, if any. There is a proposed piece of legislation that would allow private loans to be discharged, but lawmakers have taken little action on it. Any change would be a monumental revision to bankruptcy law, providing relief to many students operating under the burden of heavy student loan debt.

Source: The Baltimore Sun, "Report: Let private student loans be discharged in bankruptcy," Eileen Ambrose, July 29, 2012.

• Bankruptcy has its associated consequences, but can give debtors a fresh start. If you would like to learn more about our firm's practice, please visit our Illinois debt relief page.

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