Student loans the 'next debt bomb' for U.S., attorneys warn

Courts reluctant to discharge loans, often forcing graduates to pay off enormous sums; parents increasingly on the hook, too

Feb 7, 2012 @ 3:32 pm

By Liz Skinner

More Americans are seeking help to pay off their share of the nation's $1 trillion in student loans, setting up a debt crunch reminiscent of the nation's debilitating mortgage crisis, lawyers say.

In a survey of bankruptcy attorneys, about half reported a substantial increase in the past three to four years in potential clients with student loan debt. What's more, fully 95% of the lawyers said few of these debtors have a chance of having the loans discharged by the courts or lenders, the National Association of Consumer Bankruptcy Attorneys said.

“This could very well be the next debt bomb for the U.S. economy,” said William Brewer, president of the association. “Students and workers seeking retraining are borrowing extraordinary amounts of money through federal and private loan programs to help cover the rising cost of college and training.”

College seniors who graduated in 2010 with student loans owed an average $25,250, a 5% increase from 2009 graduates. Parents of 2010 graduates owed an average of $34,000, the association said, based on an Institute for College Access and Success report.

What's more, the number parents forced to go into debt to help pay for their kids' schooling is also increasing. In 2010, about 17% of the parents with students graduating from college that year took out loans. In 1993, only 5.6% did so.

“Evidence is mounting that student loans could be the next trouble spot for lenders,” Andrew Jennings, chief analytics officer of FICO, the top credit score company, said in a NACBA report on student loan debt released today.

Americans owe more on student loans than credit cards, according to government data. President Barack Obama is proposing a plan to offer incentives to colleges and states to make higher education more affordable, including reforms that would boost campus-based federal aid at schools with policies that aim to keep tuition costs under control. The initiatives will be detailed next week in the president's budget proposal.

Bankruptcy attorneys report anecdotally that they see more consumers seeking help with their unmanageable student loan burden and finding little relief. Those conditions are disturbingly similar to what they saw before the nation's foreclosure crisis. Because they are repaying student loans, these debtors won't be able to “engage in the consumer spending” that the economy needs to grow, said John Rao, vice president of NACBA and an attorney with the National Consumer Law Center.

Student loans “will be a drag on the economy for the foreseeable future,” he said.

The student loan default rate rose to nearly 9% for a two-year period ending in 2010, up from 7% the previous period.

Federal student loans provide borrowers a fixed, low-interest rate with low fees and multiple repayment options. However, most bankruptcy courts are “very restrictive” in determining a student borrower qualifies for a discharge, and there is no statute of limitations for the government to pursue debtors, Mr. Rao said.

Private student loans, which represent a small portion of overall student loans, are priced based on creditworthiness and most have no limits on interest rates, he said.

Bankruptcy attorneys would like to see student loan debts be eligible for discharge through bankruptcy proceedings, which was the case before congressional changes beginning in 1976. They also want a “reasonable” statute of limitations applied to the debt, the association said.

Mr. Rao said financial advisers should make sure borrowers really understand the loans they are taking out and help them determine their ability to repay them.

Adviser Greg Olsen, a partner with Lenox Advisors Inc., recommends that clients steer their students to state schools to avoid having them graduate with large amounts of outstanding student loans. A student who borrowed $20,000 a year for four years would face repayment of about $1,000 a month, he said.

“That's as much as a small mortgage, but it doesn't give the new graduate anywhere to live but in mom and dad's place,” he said. “It's difficult out there financially right now, and these kids have to graduate lean and mean.”

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