Student Loan Bankruptcy Law

This is my suggested change to bankruptcy laws for student loans. If someone declares bankruptcy, the student loans should be converted into an income based payment plan. The borrower would pay 10%-15% of their income until the loan is paid off OR 10-20 years has transpired.

Why not discharge the debt? There is a valid reason that student loans are non-dischargeable in bankruptcy. The first example is a little extreme. But, it makes the issue clear. Imagine a doctor or lawyer who goes to school for over 8 years to prepare themselves for their career. It would make a lot of financial sense for them to declare bankruptcy as soon as they graduate and start earning a 6 figure salary. This is the extreme example. But, the basic point is valid. When you are young and graduating; you have no assets and just debt. It would be great to wipe the slate clean. The problem is if enough people did that; or if lenders are nervous about people doing that; lending to students would stop.

The second reason is a little more philosophical. Anytime you borrow; you borrow against something. A mortgage is made with the house as collateral. If you stop paying, the creditor gets the house. A business lends money and if they stop paying, the creditor gets the business. Even a credit card is against your credit, so if you default your credit score is ruined. Here is how student loans are tricky; when you borrow for education; you are borrowing against the increase in skills and knowledge that you get.  If you walk away from the loan; you keep the knowledge skills while the creditor gets nothing. This is unfair. Yet, the knowledge and skills you get from school are a part of who you are. It’s not an “asset” that a creditor can claim.

There are supposed to be two people involved in the lending process. The borrower, and the lender. The lender is supposed to be the skeptic. When the lender stops being the skeptic we have huge problems. This was the issue in the mortgage industry. Lenders started securitizing and selling their loans so that they did not really care if the loan made sense. They stopped being the skeptic. This caused a lot of pain. The same thing is happening in the student loan industry. Because students can’t declare bankruptcy, lenders are not playing the skeptic in what type of education the borrower gets. They lend for any accredited school. If the lender was limited to 10%-15% of income for a specified number of years they would play the role of the skeptic and stop funding poorly performing schools.