Currently, Federal law prohibits student loan debt from being discharged during bankruptcy. But that may be changing.
Potential Changes for Student Loan Debt
Sounds like the White House is currently weighing steps that would make it easier for Americans with student loan debt to discharge certain debt during bankruptcy proceedings. This would essentially make privately held student loan debt similar to credit-card debt and mortgages.
Currently, that is not the case. Right now Federal law prohibits student loans that have been issued by private lenders and the U.S. government, from being wiped out during bankruptcy, unless rare circumstances exist. Bottom line is that it’s harder to expunge student loan debts during bankruptcy than it is to discharge lines of credit such as mortgages, credit-card balances and auto loans.
Recently, President Barack Obama directed administration officials to study whether bankruptcy options should be available for “all student loan borrowers.” This review, according to an administration official, will most likely focus on whether bankruptcy options should be expanded for borrowers that have student loans issued by private lenders – such as Sallie Mae and Wells Fargo. These lenders are not backed by the government.
Breakdown of Student Loan Lenders
Private loans, made by a lender such as a bank, credit union, state agency, or a school, make up about 10% of all student loans. The remaining 90% are held by the federal government.
Federal student loans offer many benefits, including fixed interest rates and income-based repayment plans, that are not often offered with private loans. Private loans also tend to be more expensive than federal student loans.
The Road to Change
Any changes to bankruptcy law would have to be approved by the Republican-controlled Congress. That Congress broadly opposed the president’s agenda.
The government is also expanding programs that lower student’s monthly payments while also ultimately forgiving some debt. Meanwhile, the lending industry has held on to the argument that loosening student-loan rules would ultimately drive up borrowing costs for everyone, because lenders, in an attempt to make up for lost money due to bankruptcy discharge as well as future loses because of bankruptcy, would need to raise rates.
Student Loan Debt Rising
Since 2007, total student debt has more than doubled. Federal Reserve data show that nearly a quarter of borrowers out of school now are behind on payments. The average burden among recent college grads is just under $30,000 —a small but growing share owe substantially more than that. While a good portion of those borrowers are graduate students that are bringing in decent incomes, a lot of those in debt are those who make modest to no salaries. And many of those stuck on the hook for paying back the loans are the parents who co-signed.
Borrowers who filed for bankruptcy in 2013 had an average of $32,096 in student-loan debt. That’s compared with the average of $13,456 for those who filed in 2006, according to figures recorded by Northeastern University professor Daniel Austin.
“We’re trying to make sure that across the board, more and more young people can afford to go to college, and then afterward, aren’t so burdened with debt that you can’t do anything else,” President Obama said at Georgia Institute of Technology.
Less Than 3%
The Consumer Bankers Association, which is the lending industry’s main trade group, has said that less than 3% of Americans with private student loans are in “financial distress.”
“We are working to provide flexible repayment options to keep them from finding themselves in bankruptcy at all,” the group said.
This effort is part of a larger initiative by the White House that includes setting up a system that will allow borrowers to register their complaints about the loan servicers that collect loan-payments on behalf of the government. Servicers would face more federal oversight and new rules in an effort to make them more proactive when reaching out to distressed borrowers. This initiative would also work to set up better repayment terms.
Current Attempts At Discharging Student Loan Debt in Bankruptcy
Yearly, fewer than 1,000 people nationwide attempt to discharge their student loans via bankruptcy. According to a Wall Street Journal analysis, 713 such lawsuits were filed in 2014. But that process is both expensive and uncertain. A debtor must file a lawsuit in federal court. Often this means employing a bankruptcy attorney, which can mean thousands of dollars upfront.
Additionally, bankruptcy lawyers are hesitant to take on such cases because of the wide range in results they receive. There is little to no consistency in how a judge will rule. During the bankruptcy trial, the lawyers for a bankrupt student-loan borrower has to convince a judge that the borrower will never be able to afford their monthly payment, and that this student loan debt presents an “undue hardship.” This is often a hard case to prove.
According to the National Consumer Law Center, this process of proving “undue hardship” is surprisingly arbitrary.
Because bankruptcy code does not clearly define “undue hardship” with an actual definition, the ruling that paying student loan debt back will constitute “undue hardship” is entirely up to the court. That means each individual court decides if a borrower meets the standard, and that of course, can vary from judge to judge and court to court.
Student Loan and Bankruptcy: The History
Before 1976, student loans could be discharged in bankruptcy. Amid concern regarding high default rates, Congress passed legislation in 1976 that was intended to safeguard federal investments. Which means that, starting in 1976, federal loans were automatically dischargeable in bankruptcy after a borrower had performed five years of repayment. There was an additional “out clause” that said borrowers could get out of repayment earlier than five years if repayment caused them an “undue hardship.”
Two years later, lawmakers proposed a new bill that, had it passed, would have returned the right of discharging student loan debt via bankruptcy to borrowers. But it failed, and the initial bill of the required five years of repayment stood.
In 1990 that five-year rule was extended to seven years. Eight years later, in 1998, the law was once again revised: there was no longer any set time frame for allowing discharges. From that point on, borrowers were forced to establish “undue hardship” no matter how many years of repayment they had made.
At the time, this only applied to federal student loans. In 2005, lawmakers included private student loan debt in an amendment to bankruptcy law, thus making it impossible to discharge student loan debt in bankruptcy, regardless of the form of student loan debt a borrower holds, without proving “undue hardship.”
Proving Undue Hardship
Proving undue hardship can be difficult. But it is not impossible. Here are some things you need to know if you are considering bankruptcy because of student loan debt.
Ask for Forgiveness
A lot of people that have student loan debt who file bankruptcy do not ask for their loans to be forgiven because they have heard it is impossible. Here are some statistics you must know:
- According to a Harvard law school study, 99.9% of bankruptcy filers that have educational debt don’t ask for forgiveness.
- 40% of debtors who do request for relief from student loans in bankruptcy are granted partial or total discharge of the student loans.
- Every year 70,000 debtors that file bankruptcy actually qualify to discharge some or all of their student loan debt.
You Have to Qualify
To be eligible for student loan debts to be discharged, you must first qualify. The first test to gauge this is the Brunner standard. Here are three circumstances you must meet to qualify:
- Repaying your loans will make you unable to maintain a minimal standard of living for you and your family.
- The financial circumstances that led to you being unable to afford your student loans are likely to continue through the remainder of your repayment term.
- You have made good faith efforts to repay your student loan debt.
Other debts that are a part of the bankruptcy filing will be included in your repayment schedule. Student loan debt is different. Your bankruptcy attorney will need to file an adversary proceeding, which is actually a separate lawsuit from your bankruptcy filing. Essentially, this filing means you will be suing the student loan creditor(s) to get some or all of your debt forgiven.
Three Common Characteristics
According to the Harvard study, debtors who were successful in discharging some or all of their student loans through bankruptcy had at least one of these common characteristics: they were unemployed, had a medical hardship, or had a lower income the year before filing for bankruptcy.
You Must File for Chapter 7 Bankruptcy
If you are filing for bankruptcy to try and discharge student loan debt you must file for Chapter 7 bankruptcy. Chapter 7 bankruptcy allows immediate forgiveness of all unsecured debts. This is different from Chapter 13 bankruptcy, which establishes a debt repayment plan that allows you to discharge your debts over a period of three years.
Working with a Bankruptcy Attorney
Additionally, the Harvard law study showed that hiring a bankruptcy lawyer that was familiar with adversary proceedings increased debtor’s chances of being able to prove an undue hardship, and thus discharge their student loan debt.
A bankruptcy attorney will be able to look at your specific situation and put together a plan for your bankruptcy. They will be able to advise you on if you are a good candidate for bankruptcy, in addition to which form of bankruptcy you should file.