SBPC Estimates that a Debt Load Equal to More than a Third of All Private Student Loans Can Be Discharged in Bankruptcy, Calls on Law Enforcement to Hold Industry Accountable for Decades of Fraud
January 20, 2022 | WASHINGTON, DC — The Student Borrower Protection Center (SBPC) today published the results of a sweeping investigation identifying a widespread, decades-long scheme to cheat millions of student loan borrowers out of their right to bankruptcy. Based on a comprehensive review of securities filings, student loan promissory notes, and government data, SBPC estimates that $50 billion in so-called private student loans taken on by more than 2.6 million borrowers, are, in fact, eligible to be discharged in bankruptcy despite representations to the contrary by lenders and loan servicers. SBPC’s investigation outlines the audacious tactics that some of the largest players in the private student loan market, such as Sallie Mae and Navient, undertook to convince struggling borrowers and the public that their customers did not have the right to bankruptcy. These tactics included lying to borrowers in advertisements and contracts, sending harassing collections messages to borrowers who had already undergone bankruptcy proceedings, and telling borrowers that loans were not dischargeable. At the same time, student loan companies were straight with Wall Street investors—warning that these same loans could, in fact, be discharged in bankruptcy.
A report outlining the results of the SBPC’s investigation is available here: Morally Bankrupt: How the Student Loan Industry Stole a Generation’s Right to Debt Relief
A blog post outlining the findings of the SBPC’s investigation is available here: An Industry-Wide, $50 Billion Scheme Stole Private Student Loan Borrowers’ Bankruptcy Rights
Coming on the heels of a recent settlement between Navient and a bipartisan group of 39 states attorneys general related to Navient peddling “risky and expensive subprime loans that they knew or should have known were likely to default,” the SBPC’s investigation underscores how much work remains to be done to hold the student loan industry accountable for decades of predatory practices.
“For decades, the student loan industry has lied to, stolen from, and shamelessly cheated student loan borrowers who had every right to discharge their private student loans in bankruptcy,” said SBPC executive director Mike Pierce. “Courts across the country have affirmed that this scheme was unlawful—but borrowers continue to face illegal collections, and nobody has been held to account. It is long past due for law enforcement at every level to step in, deliver borrowers their rights, and end this predatory racket.”
Student Loan Companies Padded their Profits for Decades by Lying to Struggling Borrowers
It is a commonly held belief that private student loans in the U.S. are simply not dischargeable in bankruptcy, or that they are dischargeable only after a showing of exceptional financial hardship. Both conceptions are false. Instead, only a specific subset of private student loans referred to under the law as “qualified education loans” generally cannot be discharged in bankruptcy. Loans that do not meet the specific definition of a “qualified education loan” are generally dischargeable through the bankruptcy process just like credit card debt, medical debt, or other personal loans.
For decades, the student loan industry cashed in by perpetuating and exploiting confusion surrounding which loans can and cannot be discharged in bankruptcy. Our report exposes the sheer magnitude of this fraud, finding the following:
- Banks and student loan companies developed and pushed several products that they knowingly misrepresented as not dischargeable in bankruptcy. Unsatisfied with the profits that could be made saddling borrowers with the type of private student loans that are not dischargeable in bankruptcy (that is, those that most closely mirror federal student loans), creditors developed and marketed various additional kinds of ever-more risky private credit for students. For example, lenders began offering so-called “Direct to Consumer” (DTC) loans that would be originated without intermediation from school financial aid offices, loans to students attending unaccredited credential programs such as certain cosmetology or trucking schools, loans that law school graduates could live off of while studying for the bar exam, and much more. As our report outlines, starting in the early 2000s these new, alternative products served as a booming business segment generating windfall profits for student loan companies. But while lenders widely represented to borrowers that these loans could not be discharged in bankruptcy, these lenders warned investors on Wall Street at the same time that these loans could in fact be discharged.
- Banks and student loan companies developed predatory tactics to keep struggling borrowers from discharging their debts in bankruptcy, including collecting on borrowers whose debts had already been discharged. Many of the new products that student loan companies began offering in the early 2000s did not meet the narrow definition of a “qualified education loan” that would lead to limitations on discharge in bankruptcy. But this truth proved inconvenient for lenders, whose bottom line would be harmed if struggling borrowers were allowed to access their right to relief through the bankruptcy process. Lenders consequently developed a set of brazen and robust techniques to mislead borrowers into thinking that their loans could not be discharged in bankruptcy, including:
- Banks and student loan companies put unenforceable, misleading language in loan contracts. Creditors made representations in the contracts underlying presumptively dischargeable loans that were incorrect and unenforceable but nevertheless left borrowers thinking, as industry intended, that the borrower’s loans couldn’t be discharged. For example, Sallie Mae inserted language into the contract for its generally dischargeable Tuition Answer loan stating “Not Dischargeable: This loan may not be dischargeable in bankruptcy.” Courts have gone on to rule that this assertion was wrong, and that its inclusion in loan contracts did not change that fact—but the damage in terms of misleading countless borrowers was already done.
- Banks and student loan companies took advantage of the bankruptcy process. At the end of a bankruptcy proceeding, the bankruptcy court issues an order discharging all debts listed on the bankruptcy petition except for those that are “exempt” from discharge in bankruptcy under the law—such as the limited “qualified education loans” mentioned above. But discharge orders do not specifically list which of the borrower’s loans were discharged in their bankruptcy proceeding and which were not. Given the widespread and industry-affirmed narrative that all private student loans are simply not dischargeable in bankruptcy, many borrowers who have gone through bankruptcy are left to believe that their loans were not discharged, even when they were—and their lender does not follow through in good faith to tell them the truth.
- Banks and student loan companies used abusive tactics to collect on debts that had already been discharged. In cases such as those described above, where a borrower with a presumptively dischargeable debt goes through bankruptcy proceedings unaware that their student loan is presumed to be discharged upon entry of a discharge order, lenders have compounded borrower harm through abusive collections practices. Lenders continue to hound borrowers who have gone through bankruptcy for their presumptively discharged loans, hoping that the borrower will not understand that their loan was already discharged and will subsequently continue paying up. In one case, Navient hired collectors who harassed a borrower who had already gone through discharge, contacting him multiple times per day and even calling his mother-in-law, his brother, and his wife’s employer. The court ruled that the borrower’s loans had been discharged and were not collectible—but Navient’s CEO insisted that his company would continue to hound borrowers nationwide for similarly uncollectible debt.
- Banks and student loan companies put unenforceable, misleading language in loan contracts. Creditors made representations in the contracts underlying presumptively dischargeable loans that were incorrect and unenforceable but nevertheless left borrowers thinking, as industry intended, that the borrower’s loans couldn’t be discharged. For example, Sallie Mae inserted language into the contract for its generally dischargeable Tuition Answer loan stating “Not Dischargeable: This loan may not be dischargeable in bankruptcy.” Courts have gone on to rule that this assertion was wrong, and that its inclusion in loan contracts did not change that fact—but the damage in terms of misleading countless borrowers was already done.
- The scope of the problem is massive. During the 2000s and early 2010s, the types of alternative private student loans described here were a booming business. Using public data, SBPC identified roughly $50 billion in presumptively dischargeable “private student debt” owed by more than 2.6 million people. Combining calculations of the volume of private student debt used for ineligible expenses, used to finance attendance at ineligible schools, and used to finance ineligible students, this estimate shows that the fraud uncovered in our investigation is of a staggering scale.
As our report outlines, there is both an opportunity and a dire need for public and private actors to use the tools of consumer financial protection to protect borrowers and hold industry accountable for nearly two decades of malfeasance. Courts have increasingly sided with borrowers in private litigation related to the dischargeability of the debts discussed here. It is long past due for state and federal law enforcement to build on this momentum, wielding their powers under the law to end this charade and deliver borrowers their rights. At the same time, borrowers and legal aid professionals should proceed with full, clear knowledge of borrowers’ rights under the law—and student loan companies should immediately end their policies of harmfully lying about the dischargeability of student loans.
Background: Student Loans in Name Only
The Bankruptcy Code creates heightened barriers to bankruptcy discharge only for a small subset of private student loans referred to as “qualified education loans”—loans that are taken on by legally defined “eligible students,” used to finance attendance at accredited colleges and universities that are eligible to offer students federal financial aid, and originated in amounts that do not exceed the cost of attendance at the student’s school, among other requirements. These limitations were introduced in 2005 in an effort to incentivize private student lending for products that generally mirror the basic features of federal student loans.
In turn, the law makes clear that a loan is a “qualified education loan” only if it has three key characteristics:
- It must be used at an eligible school: The borrower must have taken on the debt to attend a school that is eligible for Title IV aid, such as federal student loans and Pell grants. If the school is not eligible for Title IV aid, including because it is not accredited by a federally recognized accrediting body, then any debt used to attend that school is not a qualified education loan. Many types of loans to students at vocational programs and short-term certificate courses likely to fall into this category.
- It must be used for eligible purposes: The debt must have been used only for certain “qualified educational expenses” defined under the law. In particular, the debt must have been for a dollar value no greater than the school’s published cost of attendance less any federal loans, grants, scholarships, work-study, or other forms of aid that the student received. Loans for amounts greater than this remaining value are presumably not being used for qualified educational expenses, and are therefore not qualified education loans. DTC loans, which are not certified by the borrower’s school as being for an amount no more than the cost of attendance, likely fall into this category.
- It must be used by eligible students: The debt must have been taken on by a borrower who is eligible for federal student aid. Under the law, only U.S. citizens who are enrolled at least half-time or more (usually defined as 6 credits or more per semester) are eligible for federal student aid. Accordingly, if a borrower took on a loan while they were enrolled in less than half-time or while they were not a citizen, their loan cannot be a qualified education loan. Many loans to students studying only at night or on weekends likely fall into this category.
Regardless of how industry may brand them for marketing purposes, loan products that do not meet this specific definition of a qualified education loan are not subject to the Bankruptcy Code’s generally restrictive treatment of qualified education loans in bankruptcy. Instead, they are fully dischargeable. The millions of students who took on tens of billions of dollars of these loans have always had a right to discharge these debts in bankruptcy, and to have creditors cease collections when those borrowers have had their loans discharged through the normal bankruptcy process. Unfortunately, for decades, the student loan industry has robbed them of this privilege. It is long past time that consumer protection and law enforcement officials vindicate these borrower rights.
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The Student Borrower Protection Center is a nonprofit organization focused on alleviating the burden of student debt for millions of Americans. SBPC engages in advocacy, policymaking, and litigation strategy to rein in industry abuses, protect borrowers’ rights, and advance economic opportunity for the next generation of students.