Private Student Loan Lenders May Face Discharge of Loans in Bankruptcy and Regulation from the CFPB

If you haven’t heard it from the 24-hour news cycle, here it is: there is a student loan “bubble” waiting to burst.  Depending on your news source, there is currently up to one trillion dollars in outstanding student loan debt.  Most sources agree that Americans now owe more on student loans than on credit cards.

In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act amended the Bankruptcy Code significantly, and for the first time designated all student loans, including private student loans, nondischargeable in bankruptcy unless a debtor can prove that repaying the loans will cause an undue hardship.

No debtor wants to be eligible for a hardship discharge of student loans.  Essentially, the debtor must show they are unable to pay the loans, that conditions are dire enough that they will be unable to pay the loans for the duration of the term of the loan, and that they made good faith attempts to make payments.  This usually requires a severe mental or physical disability that prevents a person from working or making an adequate living.

Reacting to this, bills were introduced in both the U.S. House and Senate early this year to allow debtors to discharge private student loans as they would any other unsecured debt. 

Senator Dick Durbin of Illinois introduced Senate Bill 114, which would make all student loans dischargeable except loans made, insured or guaranteed by a governmental unit.  Representative Steve Cohen of Tennessee introduced House Bill 532, which would make all student loans dischargeable except  those under any program where ”substantially all of  the funds” are provided by a governmental unit. Both bills have been referred to the respective Committees on the Judiciary.

In concert with S.B. 114, Senator Durbin also introduced S.B. 133, titled “Know Before You Owe Private Student Loan Act of 2013”, which would amend the Truth in Lending Act.  This act would burden both private lenders and schools when a student applies for a private loan, and bring in the Consumer Financial Protection Bureau (“CFPB”). It was referred to the Senate Committee on Banking, Housing and Urban Affairs.

Before a private lender could extend credit for a student loan, it would be required to obtain a “certification” from the school, confirming the student’s enrollment, the cost of attendance, and the difference between the cost of attendance and the student’s financial assistance.

The school, in turn, must provide this to the lender within 15 days.  The act would impose on the school the requirement that it determine whether the student has exhausted all financial assistance options, advise the student of all federal financial assistance available with detailed loan information, and also advise on the impact the private loan would have on the student’s eligibility for other assistance. The school must further advise the student of the right to cancel the loan within 30 days after approval or 3 days after signing.

A lender could still make the loan if the school does not respond in the 15 days, but the lender would have to report the loan to the CFPB. No matter whether the lender gets the certification, it would have to provide the CFPB an annual report on all of its private student loans.  The CFPB would be charged with implementing the reporting requirements.

While bills proposing to make private student loans dischargeable in bankruptcy have been introduced before, they have not made their ways out of the committees. However, the tide may be turning to allow these bills serious consideration.  Also troubling is the proposed oversight of private loans by the CFPB.  Lenders will have substantial additional risk considerations should these bills make their way into law.