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Student loan debt reaches $1 trillion

When people decides to declare bankruptcy, they can be sure that the proceedings will enable them to eliminate most or all of their credit card debt, medical bills and many other outstanding financial obligations. What they probably can't eliminate, however, is their student loan debt.

This is because student loan debt, by law, cannot be eliminated through any form of bankruptcy. It's a relatively recent law, less than twenty years old, but it has sweeping effects on the financial situations of people carrying heavy student loan debt.

In the 1970s, loan institutions noticed that many students were declaring bankruptcy immediately following their graduation, discharging their debt and then getting a job. To discourage this behavior, a law was passed that added a 5-year waiting period for students following their graduation. That limitation was eventually increased to seven years, then again to the permanent ban that we have today.

The problem with the ban is that student loans are larger and more difficult to pay than they have ever been. Today, the total student loan debt is over $1 trillion, and unemployment among recent graduates is stubbornly high. Those who have financial troubles are unable to get out from underneath them, because they cannot rid themselves of their student loan debt through bankruptcy.

What's worse, even if a person uses Chapter 13 bankruptcy to eliminate their other debts, they will not be allowed to make the full payments on their student loan debt until the bankruptcy period is over. This means delaying the time when a student loan could be paid in full. Of course, the elimination of all other debts could put the consumer in a better place to pay off student loans once the bankruptcy is complete.

Some are now calling for the bankruptcy system to be restructured to allow people in Chapter 13 bankruptcy to make the full payments on their student loans. Others simply want student loans to be included in bankruptcy, like most other kinds of debt. It remains to be seen whether either of these ideas will gain traction in Congress; they could face stiff opposition from credit card companies who do not want to see a reduction in their share of Chapter 13 payments.

Source: The Wall Street Journal, "Student-Loan Straitjacket" Katy Stech, Sep. 30, 2013

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