Why Student Loans Are an Even Bigger Sham Than You Know
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It’s becoming an annual ritual. Every June, Congress debates what to do about the interest rate on federally subsidized student loans, to avert what this year will be the imminent doubling from 3.4 percent to 6.8 percent. But interest rates alone don’t tell the whole story.
At a time when overall student debt approaches $1 trillion, the facts reveal that student loans aren’t loans, not in the traditional sense. They exhibit none of the qualities of modern consumer financial instruments, and are often sold under false pretenses, with the promise of a lifelong benefit that never materializes. We need to change how these loans work and have a broader conversation about what we should be doing — including bankruptcy and refinancing — to help future generations obtain a quality, affordable education, which is critical to our economic future.
The roughly two-thirds of U.S. students who take out loans to finance their college education can end up in a situation most resembling the historical concept of indenture. In medieval times, peasants would sign deeds to work land, which would then get cut in a jagged line (looking like teeth, or “dentures”). Each party would get half, and rejoining them would prove the authenticity of the contract. Colonial indentures would trade years of labor for the opportunity of transportation to the New World. The indentured could not alter the terms of the contract, no matter their circumstances. One way or another, the debt would get paid.
This is basically how student loans work. A college student might remember freshman orientation, when an instructor told them to look to their left and right, explaining, “One of you won’t graduate.” But student loans aren’t extinguished for those who don’t finish college; instead, the debt becomes a burdensome reminder of this early mistake in life. This is also true for students snookered into matriculating at sketchy for-profit colleges, which offer almost no marketable skills or career preparedness to justify the cost. And it further describes recent college graduates who, through an accident of timing, entered the real world during the Great Recession and its aftermath, finding it difficult to obtain work in their field of study.
Due to these combined factors, delinquency rates for student loans – unlike auto, credit card or even mortgage debt – have risen the past two years, according to the Federal Reserve Bank of New York. But student debt is something you carry for the rest of your life. It’s nearly impossible to refinance student loans, despite the current low-rate environment, primarily because of the high credit risk and lack of collateral. And unlike most other loans, you cannot get rid of student debt through bankruptcy.
This happened almost by accident. Before 1976, student debt was treated the same as any other in the bankruptcy process. Amid rising default rates – yes, even back then – Congress got it in its head that people were ripping off the government for a free education and then shedding the loans (a couple of well-placed stories about doctors declaring bankruptcy after graduating from medical school added to the panic). In an effort to stop this, Congress passed a law permitting students only to discharge loans in bankruptcy five years after origination, unless they demonstrated undue hardship.
In 1990 the five-year rule was extended to seven years, and then in 1998 Congress dropped that requirement altogether, making undue hardship the only way to discharge student loans in bankruptcy. And undue hardship is a very large chore to prove, according to Bob Lawless, law professor at the University of Illinois. “The courts require proof of an inability to get by without a modification,” Lawless told Salon. “They’re reluctant to allow a discharge if someone just has a lower-paying job and can’t afford the payment.” So the bankruptcy law has become harsher at the same time that college tuition has ballooned, increasing demand for student loans. As then-law professor Elizabeth Warren said in 2007, “Why should students who are trying to finance an education be treated more harshly than someone … who racked up tens of thousands of dollars gambling?”