The number of former students who are defaulting on student loans and the size of the loans has the potential to adversely impact the entire U.S. economy, as well as hurt the people holding the loans, according to experts in the field.
Student loans have been characterized by some as the next big crisis after the home mortgage debacle. Advocates are lobbying Congress to change the rules to make it easier for students to get out from under these massive debts by declaring bankruptcy.
At the same time, organizations such as Merrill Edge Bank of America are encouraging parents to begin saving for their children's college educations as soon as they are born to try to stave off some of the necessity for loans when they child reaches college age.
More than four out of five bankruptcy attorneys say that potential clients with student loan debts have increased significantly or somewhat in recent years, according to the National Association of Consumer Bankruptcy Attorneys. At the same time, 39% of bankruptcy attorneys have seen their potential student loan client cases jump from 25% to 50% in the last four years. An additional 23% of the attorneys have seen such potential cases jump by 50 % to 100%.
The reason they are potential clients and not clients is that most bankruptcy attorneys report that few student loan debtors are seen as having any chance of obtaining a discharge of their debts as a result of undue hardship by declaring bankruptcy because of the way the federal laws are written. This applies to federal and private loans.
The attorneys association calls this a "debt bomb" in the report, America's Next Mortgage Style Economic Crisis.
College seniors who graduated with student loans in 2010 owed an average of $25,250, an increase of 5% over the previous year. In addition, borrowing has grown far more quickly for those in the 35 to 49 age group who are returning to school. Their debt burden has increased by 47% since 2010.
Parents also are drowning under debts for loans they co-signed for their children, with the number having jumped 75% since the 2005-2006 academic year. Parents have an average of $34,000 in student loan obligations.
Of the class of 2005 borrowers who began repaying when they graduated, one in four already became delinquent at some point and 15% defaulted. The Chronicle of Education puts the default rate on government loans at 20%.
A 2011 Merrill Edge Report revealed 44% of parents began saving for college before their child reached the age of six, but 38% wished they had started even earlier. At the same time, only a third of those surveyed said they plan to focus on college savings in the next six months.
That is bad news, according to the bankruptcy attorneys, who say the effect of student loans can hurt the entire economy as students cannot get jobs once they graduate with debt hanging over their heads and some young people avoid going to school because they do not want to incur the debt.
Changes in bankruptcy laws in 2005 made it harder for students to discharge debt through bankruptcy no matter how dire the circumstances, said U.S. Representative Steven Cohen, who participated in a recent teleconference by the Bankruptcy Attorneys Association. Cohen is sponsoring a bill to make it easier for students who cannot repay to declare bankruptcy and have a chance to rehabilitate their finances.
There is also a problem of disreputable private loan agencies making loans they know students will not be able to repay, said John Rao, attorney at the National Consumer Law Center and vice president of the National Association of Consumer Bankruptcy Attorneys.
Students need to know the terms of the loan and whether they have a reasonable expectation of repaying it, he said, or you end up with the same situation as the bad mortgages that were made in recent years.