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Bankruptcy lawyers are warning that student debt could trigger an economic mess on par with the mortgage crisis.
“Americans now owe more on student loans than on credit cards,” says a study released by the National Association of Consumer Bankruptcy Attorneys this month. “Total outstanding loans exceeded $1 trillion for the first time last year.”
And unlike credit card debt, student loans can rarely be discharged through bankruptcy. The person filing has to demonstrate “undue hardship,” which is difficult and rarely successful. This 2009 USA Today article explains…
A student loan debtor must try to claim an “undue hardship” to seek bankruptcy protection – a claim that is successful at best about 50 percent of the time. Unlike a traditional bankruptcy filing, a hardship filing requires debtors to file a lawsuit against creditors. That pits the student against corporate lawyers and defense teams, and often requires an expert witness, which can cost the graduate thousands of dollars to arrange.
This isn’t a new problem – student debt has ballooned more than 500 percent since 1999. And while the loan default rate was much higher in the early 1990s, the number’s been trending back up since 2005 – suggesting what the NACBA is calling a potential “debt bomb.” Their survey says almost half of bankruptcy attorneys have seen “significant increases” in potential clients. In fact, 2 in 10 have seen their caseload jump more than 50 percent, and another 4 in 10 have a 25 to 50 percent larger caseload.
So the NACBA is now calling for the government to allow student loans – both private and federal – to be cancelled in bankruptcy, as they were prior to 1976.
Even if that were to happen, it’s still far from ideal for both the taxpayer and the graduate. Most bad marks on your credit report stay there for up to seven years. Bankruptcy sticks around for as many as 10 and can knock up to 240 points off your credit score, making it difficult to get credit and possibly even employment.
Here are some better ideas for negotiating student loans, from start to finish…
- Avoid loans altogether. There’s a lot of financial aid that doesn’t require repayment, and some of it goes unclaimed every year. Fill out the Free Application for Federal Student Aid every year you’re enrolled, even if you don’t expect to qualify for aid – this tells the school’s financial aid office you’re interested in whatever opportunities are out there. Also check out our stories, 25 Bizarre Scholarships and 6 Top Tips for Finding College Aid. Browse big scholarship databases like FastWeb. Even if you don’t meet the eligibility criteria, be honest about it and apply anyway – the worst that can happen is a rejection notice. If nobody more qualified applies, you just might win.
- Choose a school based on price, not prestige. There are a lot of factors to consider when choosing a college. But if you’re concerned about your financial future, it may be more important to seek a school with lower tuition or a stronger aid package than one with good networking opportunities or a respected name. If you have to take out loans, their total shouldn’t be higher than twice the salary an entry-level worker makes for your field of study – and the lower, the better.
- Opt for subsidized federal loans first. Student loans come in two major types: government-backed and private. The latter come with much higher interest rates and generally less-flexible repayment terms, but families sometimes turn to them after hitting the maximum for federal loans. Some federal loans are subsidized, meaning their interest is covered by the government while you’re in school – take the maximum available before turning to unsubsidized loans, and federal unsubsidized loans before private loans. For more on the different types and their limits, check out FinAid.org’s student loan page.
- Repay as much as you can quickly. Don’t take out more than you need, and start setting aside as much money for repayment as soon as you can. Read How I Wiped Out $37,000 of Debt in One Year. It’s the story of a reader who took our advice and changed his whole outlook on paying off debt. Money isn’t everything – motivation is. In his case, shifting priorities and seeking help were enough to turn things around. In our reader’s words, “We didn’t alter our lifestyle much, but I did give up my gym membership for seven months.”
- Seek loan forgiveness. Some professions, especially in public service, can lead to forgiveness of your student loans. It’s not a short road out – still requiring years of loan payments and staying in one place full-time – but teachers, lawyers, soldiers, volunteers, and certain other professionals may benefit from loan-forgiveness programs.
- Try everything before default. When you absolutely can’t make your payments, talk to your lender about a forbearance or deferment. Letting months go by without paying or making arrangements can have serious consequences, including credit damage, being sued for the full value of the loan, having money sucked out of your paycheck and your tax refunds confiscated, and losing government benefits. You may even lose a professional license or be blocked from military enlistment. The time to talk to your lender is as soon as you know there’s a problem.
For more help, check out Struggling With Student Loans? Here’s What To Do.