Evidence has been trickling in that strategic default—that is, default due to unwillingness to repay a debt rather than inability to do so—is not really a factor in mortgage defaults. At least, that’s what one study about unemployment and mortgage default found. A similar hypothetical question is whether New York bankruptcy debtors would strategically default on their student loans if some of the restrictions on them were lifted. Put differently, do the limitations on discharging student loans in bankruptcy perform their intended functions of preventing strategic student loan defaults? It’s a question that one research paper from February 2017 tries to answer.
The reason the question is important is that strategic default on student loans has never been measured empirically. The initial restrictions on student-loan debt in bankruptcy emerged in the 1970s because lawmakers believed without evidence that debtors with high student-loan balances and high incomes, like doctors, were discharging their loans shortly into their professional careers. If that perception were true, the thinking goes, then the bankruptcy restrictions are justified. Unfortunately, it’s hard to find evidence of strategic defaults on student loans, even among the large number of current debtors, because it’s difficult to separate strategic defaulters from scrupulous ones.
To address this empirical deficiency, the paper looks at changes in policies that altered the cost of defaulting to borrowers and not their ability to repay their loans. The idea is that if more borrowers default under different conditions, then strategic default is a likely explanation. The first such policy change the paper looked at was in the late 1990s, when Congress replaced the seven-year window on the limit to student-loan dischargeability with a permanent restriction. Specifically, it compared two different groups of borrowers who had reached end of the seven-year window, those who did so just before the law was changed and those after.
The paper found that borrowers were 18 percent more likely to default on their student loans when bankruptcy protections were available to them after seven years. The figure sounds high, but the actual difference was just 0.25 percentage points, and figures at the end of the paper suggest that the overall default rate was low after seven years regardless of the policy. No matter what the absolute number was, this is not many debtors. Later in the paper, the author estimates that restoring bankruptcy protections to the 1990s system would only lead to $20 billion in additional debt discharged. This would be less than 2 percent of all student loans out there.
Another policy reform the paper looked at was a change in 2006 to the student-loan wage-garnishment law. Introduced in the early 1990s, creditors (the federal government these days) could garnish debtors’ wages above a certain income threshold without a court order when the debtors defaulted on their student loans. The change in 2006 increased the rate of garnishments, so comparing debtors with incomes above and below that threshold around 2006 showed that every additional $10,000 of garnishable income led to a 15 percent decrease in student-loan default rates. Again, the difference between the percentages was small, less than 1 percent.
The paper concludes that evidence of strategic default by student debtors does not necessarily justify the bankruptcy restrictions for student loans. Indeed, strategic default in student loans is no more common than for other types of debt. The paper can be found here (pdf).
Debtors who have defaulted on their student loans often owe other debts they’ve defaulted on. If you owe significant student-loan debts, then consulting with an experienced New York bankruptcy lawyer can help you assess your options. Filing a chapter 7 bankruptcy can free up income for student-loan payments, and chapter 13 has its advantages as well.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy attorney Brooklyn NY Bruce Weiner for a free initial consultation.