Attorney Billy Brewer is warning that there’s another big economic problem lurking on horizon: student loan defaults.
Back in 2007, Brewer, who also serves as president of the National Association of Consumer Bankruptcy Attorneys (NACBA), testified before Congress that he and fellow attorneys were worried about the sharp rise in the number of homeowners seeking advice about filing for bankruptcy because they couldn’t afford to pay the rising rates on their subprime mortgages. At that time, says Brewer, “The mortgage industry said, ‘We’ve got it under control.’ They were wrong.”
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Today, bankruptcy attorneys are sounding the alarm about what they see as another disturbing trend: the rising number of student loan defaults. According to an NACBA survey, half of its members have seen a significant increase in the number of individuals seeking help with crippling college debt. One in four attorneys reports the number of these cases they’re handling jumped by at least 50%.
According to an analysis released last month by credit report provider FICO, consumers owe $750 billion in student loan debt--more than what Americans owe on their credit cards.(1) Here’s more bad news: 67% of lenders now expect student loan delinquencies to increase- a 19% jump in just three months.
In a January press release, FICO’s chief analytics officer Dr. Andrew Jennings wrote: “Evidence is mounting that student loans could be the next trouble spot… A significant rise in defaults on student loans would impact lenders as well as taxpayers, who could be facing big losses due to these defaults.”
While no one is saying the problem is on the same scale as the disastrous 2008 collapse of the mortgage market, Brewer worries that “long-term, it could have a very chilling effect on the U.S. competing in the world economy. People will look at the risk reward of getting a degree or studying something that could lead to the next advance in science, and decide that borrowing $100,000 to get a PhD isn’t worth it.”
The economy is a major obstacle for students. The recession and continued high unemployment have made it tough to find a job after graduation, and just one missed payment on a student loan makes a grad immediately classified as delinquent. After nine months, the loan is considered to be in default. According to NACBA, once that happens, “the full amount of the loan is due immediately. The government also cuts off any future federal financial aid and strips the borrower’s eligibility for loan forgiveness.” Brewer and other attorneys report that collection agencies--which are used by both private and government lenders--have become more aggressive in terms of suing.
For students who don’t technically default on a student loan, due to changes in federal bankruptcy law made in 2005, getting “forgiveness” is nearly impossible. In bankruptcy, student loans are treated differently than other debt. “If you have credit card debt and default, a creditor has three to five years to file suit,” said Brewer. While there is a statute of limitations on private student loans, there’s none on federal ones. “It can be 25 years later and you can still be sued. It goes with you to your grave.”
According to the credit monitoring website CreditKarma.com, the average amount of student loan debt per consumer was $29,572 a year ago, up 6% from the year before. But in some states it was much higher: In Wisconsin, for instance, the average amount rose 17%, and in Oklahoma, 16%. While 20-somethings still owe the lion’s share of this debt, those ages 35-49 have seen the biggest increase in student loans. Many in this age group went back to school to get re-trained after losing their job due to layoffs, downsizing or industry changes. “But it’s not just the cost of school. Perhaps they’re not working. And, unfortunately, they’re not even finding jobs once they get the education,” says Brewer.
Baby boomer parents who ought to be saving for their own retirement at this stage in life, are also finding themselves in trouble. Many took out parental PLUS loans to help pay for a child’s college education; all it takes is for one spouse to lose their job and suddenly they’re behind on payments.
Whether students have a federal or private student loan, it can’t be discharged by simply filing for bankruptcy. According to Brewer, the only hope is to allege and prove that it would constitute “undue hardship” to pay the debt. “The courts have construed that really harshly. It’s Draconian.” He explains that students must meet three standards:
1. Prove that based on your current income, you have absolutely no money left after paying for bare necessities such as food, housing, etc.
2. Demonstrate that your financial situation is never going to improve for the rest of your life. “You can’t be temporarily down-and-out and get rid of your student loans,” says Brewer.
3. Made a good faith effort to repay the money. Unfortunately, the minute you fall into default, you are no long considered to be acting in “good faith.”
Brewer tells the story of a 67-year-old client with a graduate degree in sociology and $116,000 in federal student loans. “Eventually she finds a clerical job paying $26,000 a year and she’s getting Social Security of $250/month. The bankruptcy court in the eastern district of Virginia discharged her loan. The government appealed and the 4th Circuit [Court]… said her student loans could not be discharged.”
For students with a “direct” loan from the federal government, relief may be available provided they qualify for what’s called an “income contingent repayment plan.” The debt is not erased, but the repayment period may be extended and the monthly payments will be reduced based upon what the government calculates is affordable. According to Brewer, “At the end of 25 years, the debt [remaining] will finally be forgiven."
But keep in mind that federal loans also have garnishment rights, which means the government can pay itself back by taking a piece of borrowers’ paychecks or withholding an income tax refund. For retired people who co-signed a federal student loan on behalf of a child or grandchild, a portion of their monthly Social Security check will be withheld.
NACBA has called on Congress to change the bankruptcy law and re-impose a statute of limitations on federal student loans. The organization points out that “…statutes of limitation apply to nearly all federal criminal actions. The rare exceptions exist for those crimes that are punishable by death, including espionage and treason, and now, student loan defaults.”
1. Other estimates run as high as $1 trillion.
Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.
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