New Hope for Debtors Struggling With Student Loans

Hundreds of thousands of Americans who fall behind in their bills and seek refuge by filing for bankruptcy get a distressing surprise: If they are willing to ruin their credit for years, they can walk away from their houses, turn in their cars, and wipe out their credit card bills, but they typically can't erase a penny of their student debts. 

Of course, the vast majority of Americans who use loans to pay for college get jobs and pay their debts. But the recent economic troubles and spike in unemployment have caused thousands of graduates to fall behind on their student loan payments. More than 20 percent of students who took out expensive private loans in the last several years to pay for tuition at some for-profit colleges have defaulted. The government reports that 6.7 percent of those who took federal student loans in 2007 have already defaulted, up from 4.6 percent in 2005. And many analysts predict more Americans will have trouble paying their student loan bills in the coming months. 

Recent developments in Washington hold out new hopes for anyone struggling with student loans, however. Several Congressional Democrats, including Minnesota Sen. Al Franken and Illinois Sen. Dick Durbin, are pushing for a reform to allow those who file for bankruptcy to get out from under at least some of their private educational loans. 

"In this economy, we want to be encouraging people to invest in their education and their future," Franken said in a press release. "That's why it is more important than ever for people to be able to get a fresh start." 

If the plan wins Congressional approval, it would mark the third big improvement in student loans in the last year, student groups say. 

Last summer, the federal government started allowing those with federal student loans to cap their payments below 15 percent of their income, and it promised to forgive some of the debts of public servants, and those with low incomes. Earlier this year, Congress beefed up the new "Income-Based Repayment" plan so that those who take out federal student loans after 2014 can cap their payments below 10 percent of their income. 

[Get the details on income-based student loan repayment.] 

In March, the Supreme Court set a small but hopeful precedent for borrowers. It backed a borrower who had persuaded a bankruptcy judge to reduce his federal student loan debt, rebuffing attempts by a collector to reinstate the entire debt. 

Now that federal borrowers have a chance at relief, attention is turning to the estimated 17 million Americans currently paying down private student loans. Valisha Cooks, a University of Phoenix graduate and single mom who lives in Long Beach, Calif., told Congressmen at an April 22 hearing on the Congressional proposal that she's glad the new income-based repayment plan allows her to pay down her federal loans. But she said debtors like her need "a light at the end of the tunnel" for private loans. Although Cooks filed for bankruptcy, Wachovia has refused her efforts to negotiate an affordable payoff plan, and keeps adding interest and fees to her original $36,000 private loan. Today, she figures she owes Wachovia $53,000. "I send them whatever I can afford each month--usually about $120," but she says collection agencies "still call and threaten to send my account for wage garnishment. I live in constant fear that the hammer will one day drop and ruin my life and any hope for my son's future. It's a scary, hopeless feeling." 

A spokesperson for Wachovia, which was purchased by Wells Fargo at the end of 2008, says it offered Cooks a chance to skip six months of payments, though it would keep adding interest during that time. As for the Congressional proposals, Wachovia said it went along with its trade organization, the Consumer Bankers Association, which warned Congress that offering relief to current debtors could hurt future students. "If this legislation passes, lenders will face increased losses from loan defaults. This will result in higher fees, higher interest rates and even tighter credit screening—the opposite of what is needed to expand access to affordable higher education," the CBA stated.