As the US student loan crisis could become a time bomb that implodes, a new report from the Brookings Institute identifies the problem and legislation is set to address concerns.

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Small portion of US student debt to be discharged the bankruptcy

US Senator Tom Harkin (D-IA) is prepared to reveal legislation Wednesday that would allow the small portion of US student debt that was privately financed to be discharged the bankruptcy, the Wall Street Journal is reporting.

Most of the $1.1 trillion in student debt is held by the US Education Department and would not be subject to bankruptcy.  Only about 10 percent to 15 percent of debt issued by private lenders, such as Wells Fargo, Discover Financial Services and SLM Corp (NASDAQ:SLM), could be subject to default.

Observers have warned of a student debt crisis. The Brookings Institute yesterday published a report titled “Is a Student Loan Crisis on the Horizon?”

“College tuition and student debt levels have been increasing at a fast pace for at least two decades,” the report said. “These well-documented trends, coupled with an economy weakened by a major recession, have raised serious questions about whether the market for student debt is headed for a crisis, with many borrowers unable to repay their loans and taxpayers being forced to foot the bill.”

The three conclusions

The report drew three primary conclusions:

  • Roughly one-quarter of the increase in student debt since 1989 can be directly attributed to Americans obtaining more education, especially graduate degrees.  The average debt levels of borrowers with a graduate degree more than quadrupled, from just under $10,000 to more than $40,000.  By comparison, the debt loads of those with only a bachelor’s degree increased by a smaller margin, from $6,000 to $16,000.

  • Increases in the average lifetime incomes of college-educated Americans have more than kept pace with increases in debt loads. Between 1992 and 2010, the average household with student debt saw an increase of about $7,400 in annual income and $18,000 in total debt.  In other words, the increase in earnings received over the course of 2.4 years would pay for the increase in debt incurred.

  • The monthly payment burden faced by student loan borrowers has stayed about the same or even lessened over the past two decades.  The median borrower has consistently spent three to four percent of their monthly income on student loan payments since 1992, and the mean payment-to-income ratio has fallen significantly, from 15 to 7 percent.  The average repayment term for student loans increased over this period, allowing borrowers to shoulder increased debt loads without larger monthly payments.

Student loan default prohibited by Federal law

Federal law currently prohibits student loan default except in rare cases. Backers of the status quo say making such student loans difficult to discharge, including those in the banking industry, argue the policy keeps interest rates low by reducing the risk for lenders. Consumer advocates, on the other hand, say bankruptcy is a last gasp option and not allowing debt to be discharged is keeping some borrowers trapped under debt burdens so high they won’t logically be able to ever repay the loan. Most other types of consumer debt, including money owed on mortgages, credit cards and auto loans, can be discharged in bankruptcy.

The article said the bill isn’t likely to pass this year, given the midterm elections and broad partisan disputes over higher-education policy. Rather, the bill “sets a stake in the ground for Democrats in talks on a final bill.”