Portrait of young man in graduation gown with father on campus © Thomas Barwick, Digital Vision, Getty Images

The mortgage mess might have been over by now if we'd done just one, sensible thing. We should have given bankruptcy judges the power to restructure home loans.

Bankruptcy judges can alter mortgages for commercial, rental and vacation properties to make them more affordable. But they can't touch home loans. So mortgage lenders had no incentive to help people when loans that never should have been made started to blow up. Instead, lenders lost people's paperwork, gave contradictory advice and promised modifications even as they proceeded with foreclosures.

If bankruptcy judges could fix home loans, far fewer lenders would have given homeowners the runaround. Knowing they could lose big-time in court, those lenders would have properly staffed their mortgage-modification divisions and started offering deals. The threat of bankruptcy would have been the leverage homeowners needed to get real help.

It's too late now. But we have a chance to fix another mess by allowing bankruptcy judges to modify private student loans, which never should have had bankruptcy protection in the first place.

Federal vs. private student loans

Private student loans are different from the federal loans that make up the vast majority of education debt. Federal loans:

  • Are made or guaranteed by the U.S. government.
  • Have relatively low fixed rates that aren't based on credit scores.
  • Offer generous deferment and forbearance options, which temporarily suspend the obligation to repay the debt when the borrower is experiencing financial hardship.
  • Offer flexible repayment options, including income-based plans that limit payments to 15% of disposable income. That generally works out to less than 10% of gross income, according to financial aid expert Mark Kantrowitz of FinAid.org. The required payments can drop to zero for very-low-income borrowers.
  • Include the possibility of forgiveness with certain kinds of service and after 10 to 25 years of payments.

Image: Liz Weston

Liz Weston

Private student loans, by contrast:

  • Don't include government guarantees or use taxpayer funds.
  • Are often made by for-profit lenders.
  • Usually require co-signers.
  • Typically have variable interest rates that are based on the borrower's (or co-signer's) perceived credit risk.
  • Have limited repayment options and virtually no possibility of forgiveness. Many lenders don't offer forbearance or income-based payments in case of financial hardship; a big complaint from borrowers is that lenders refuse to offer affordable payment plans.
  • May require the borrower to make payments while the student is still in school.

Federal student loans are made to enable people to get a higher education. Private student loans are typically made to earn a profit.

Private student loan volume was pretty negligible until the past decade, when so-called "asset-backed securities" became hugely popular with investors. Lenders learned they could make big profits by bundling mortgages, auto loans, credit card debt and yes, student loans, and selling them to investors. The volume of private student loans quadrupled between 2001 and 2008 to more than $20 billion, according to the Consumer Financial Protection Bureau.

The problem was that in their haste to make money, lenders stopped paying attention to whether the loans made sense. Which is how people earning $40,000 got $300,000 mortgages, and how undergraduates wound up with six-figure student loan debts.

The rules are different now

Once upon a time, borrowers could get some relief, since student loans could be erased in bankruptcy court. Starting in 1976, the rules began to tighten. Borrowers were required to pay their loans for at least five years; later, that was extended to seven. Then in 1998, Congress changed the law to make it all but impossible to discharge federal student loans in bankruptcy court. Many private lenders got protection as well by affiliating with nonprofit guarantors to make the loans. But in 2005, the bankruptcy reform law extended the protection to private student loans regardless of whether a nonprofit or government agency was involved.

With that kind of legal protection, private student loans joined a short list of debts that can't be erased. That list includes child support, alimony, tax liens and claims arising out of wrongful conduct, such as a judgment against a drunk driver who kills or injures somebody.

Tax liens and federal student loans are money owed to the government. Child support and alimony are obligations that can keep people off the public dole. Prohibitions on erasing judgments from wrongful conduct just make sense.

Protecting private student lenders? Not so much.

I'm not suggesting we allow student borrowers to dance away from obligations they voluntarily took on (even if they were teenagers with little idea of what they were getting into). Just dialing the rules back to 1997, when student loan borrowers had to make at least seven years of payments before discharge, could make a big difference. Even better would be returning to the days prior to 1989, when only five years of payment were required before borrowers could get a discharge of their education debt.

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Because what troubled borrowers need isn't necessarily erasure of their debt. What they really need are lenders willing to play ball -- to offer sensible payment options to people who are struggling. Taking away the bankruptcy exemption would give borrowers a pretty big bat to bring to the game.

Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.