Loophole May Let Some People Off the Hook for Their College Loans Because of a long-forgotten federal law, students may have a new, possibly short-lived, debt-forgiveness plan.

By Lindsay Friedman

Opinions expressed by Entrepreneur contributors are their own.


Thanks to a small loophole, folks whose finances are contributing to the nation's $1.2 trillion in total student loan debt might not have to ante up.

More than 7,500 people, owing roughly $163 million in student loans, have applied to have their debt waived in the last six months. The majority claim their schools deceived them with false promises of job placement and high paying positions, according to an article from The Wall Street Journal.

The surge comes after the U.S. Department of Education agreed to cancel nearly $28 million in debt for 1,300 former students from Corinthian Colleges after it was liquidated in bankruptcy and closed. During the case, multiple prominent lawmakers supported students' claims in a letter urging the court to rule in their favor. After the decision, department officials indicated more students were likely to be granted forgiveness as well.

Related: The Changing Economics of Student-Loan Debt: How to Pay It Off and Startup

The legal dispute is the direct result of a law included in an 1994 version of the Higher Education Act, which introduced "borrower defenses." Though it was meant to be temporary, it was eventually forgotten and left untouched by legislators.

"Notwithstanding any other provision of State or Federal law, the Secretary shall specify in regulations which acts or omissions of an institution of higher education a borrower may assert as a defense to repayment of a loan made under this part," the legislation reads.

A segment relating to the policy is also still included at the end of forms for the William D. Ford Federal Direct Loan Program:

"In some cases you may assert, as a defense against collection of your loan, that the school did something wrong or failed to do something that it should have done. You can make such a defense against repayment only if the school's act or omission directly relates to your loan or to the educational services that the loan was intended to pay for, and if what the school did or did not do would give rise to a legal cause of action against the school under applicable state law. If you believe that you have a defense against repayment of your loan, contact your servicer."

As college enrollment increased and loaning companies allegedly took advantage of students, activists from movements such as the Debt Collective started to take a closer look at the issue. The group teamed with former Corinthian students, which is when the long-dormant law was discovered.

Because of the snaffu, the Department of Education assigned a special master for borrower defense, Joseph Smith, to provide a summary and analysis of legislation and events in a series of reports.

"The unfortunate reality is that some colleges, including certain career colleges, have used abusive practices to prey on students," Smith says in the first report.

The effort coincided with federal education department undersecretary Ted Mitchell's goal to "hold career colleges accountable for giving students what they deserve -- a high-quality, affordable education that prepares them for their careers."

"We just don't know" the potential scope, Mitchell says in an article in The Wall Street Journal. "This is new territory for us."

Despite an effort to provide insight on the issue, debate surrounds the law's potential application, because the department says it's "overly vague." For instance, Smith's report states the law doesn't specify what proof is needed to prove the school committed fraud or any wrongdoing.

Nonetheless, most lawmakers agree reimbursement could possibly be received if students have been defrauded. In that case, the long-forgotten law could end up costing the government billions of dollars before all is said and done.

For that reason, Steve Rhode, a consumer debt expert known as the "Get out of Debt Guy," writes in a Huffington Post blog post that he expects the loophole to be closed quickly.

In fact, negotiations started last week involving the education department, students, schools and lenders to create a set of clear rules. For example, when the department can go after institutions to get student-loan-funded tuition money back will be a part of the discussion.

But even with an ongoing discussion, officials are still struggling to understand the law's possible implications or what the bill would eventually look like.

Related: How to Keep Student Loans From Idling Your Entrepreneurial Dreams
Lindsay Friedman

Staff writer. Frequently covers franchise news and food trends.

Lindsay Friedman is a staff writer at Entrepreneur.com.

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