This post is in no way intended to be legal advice.
While you are able to declare bankruptcy to eliminate many types of debts, student loans remain one of the few exceptions. Currently, student loans cannot be discharged through traditional bankruptcy proceedings. Regardless of your income status or how far you might be behind on your loan payments, the fact is that discharging your student loans through bankruptcy, at this time, is not an option. However, there are signs that this may be changing in the future.
Your Student Loan Discharge Options
While traditional bankruptcy is not yet an available option, there are procedures that can be attempted to get student loans discharged, although they are anything but easy. These procedures apply to both federal and private student loans and exist outside the traditional bankruptcy process. Congress made federal student loans ineligible for discharge to ensure the solvency of the federal loan program. However, if borrowers can prove that they meet certain criteria, exceptions have been made. But again, the process is very arduous.
(In addition, a recent court case shows that discharge may also be possible if the borrower can prove their student loan did not constitute an “educational benefit.”)
If you do decide to pursue the discharge process, here are the required steps:
- Start with an Adversary Proceeding – This is an actual lawsuit filed as part of a bankruptcy case to have your student loans discharged (but will be handled separately).
- Prove “Undue Financial Hardship” – In order to “win” this lawsuit, you must prove to a judge that repaying your student loans would be an undue financial hardship on you and/or your family.
This hardship must meet what is known as the Brunner Standard. To meet this standard, you must prove three points:
- You (and any dependents) cannot meet a very basic standard of living on your current income and still pay your student loans
- Your current financial situation is going to continue for an extended period of time that will likely cover the entirety of your loan term
- You have attempted to make a good faith effort to repay your loan prior to filing for a discharge
The standards for these points are very strict and often very difficult to prove (some even argue “impossible”). In addition, the attorney fees for even attempting a discharge are also typically high, leading to very few borrowers even bothering to try.
- Proceed to the Court’s Decision – If you are able to successfully prove the above criteria and get your federal student loans discharged, you will not be required to make any further payments. Collection calls will also stop at this point.
(If you’re interested in learning more about student loan discharge, click here.)
So now that we understand the current obstacles to getting student loans discharged let’s look at the arguments for and against allowing for bankruptcy reforms in the future.
The Arguments For and Against Student Loan Bankruptcy Options
When discussing the allowance of student loan bankruptcy options in the future, it’s important to understand how we got to where we are today. Let’s (very) briefly go over how the current bankruptcy situation came about.
Before 1976, the educational debt was fully dischargeable in a bankruptcy proceeding. Then, in an effort to preserve the solvency and availability of federal loans, legislation was passed that mandated a five-year waiting period before borrowers could attempt to have student loans discharged. This period was then extended to seven years, and in 1998 student loans were then prohibited from discharge at all. The stated reason at that point was the “prevention of fraud and bankruptcy abuse by student loan borrowers going forward.”
And it’s remained that way ever since.
Proponents of keeping student loan discharge off the table argue that since borrowers had no collateral to pledge for their loans when they received them—other than future potential earning power—then their loans should be required to be repaid (as there is no other collateral to be acquired in its place). However, those that favor of reforms argue that the student loan crisis has reached such a degree that bankruptcy options should be adjusted accordingly to combat this worsening trend. They also argue that the cost of education and the general employment landscape have changed significantly and should be factored in as well.
For example, in many cases tuition had risen 2,000% from where it was in 1976 when student loans were still dischargeable. At the same time, the average household income hasn’t increased since early 2000.Supporters of bankruptcy reform also argue that as long as student loans are nondischargeable, lenders have no incentive to responsibly underwrite them. In fact, they are able to profit continuously off of just interest and fees even if their borrowers don’t pay. They also argue that the addition of bankruptcy options would remove significant amounts of predatory lending. The risk of discharge would force lenders to be much more cautious when offering student loans. While this would undeniably result in fewer loans being made and fewer students attending college, the value of individual degrees would rise, and tuition rates would fall as a result. Therefore, the allowance of student loan discharges through traditional bankruptcy, they argue, would then create an “upward spiral” in the student loan industry from that point forward. However, the likelihood of these changes happening soon (if at all) is still anyone’s guess.
The Future of Student Loan Bankruptcy (And Our Recommendations for Reforming It)
While bankruptcy options for student loans currently remain off-limits, there is legislation now being considered that could change this, but each bill is finding minimal support at this time. But with so many borrowers simply unable to pay off their student loans going forward, changes will have to be made. President Trump has yet to address student loan bankruptcy reform directly, although he has put forward a plan for dealing with the student loan crisis going forward.
Here are a few reform ideas that, if implemented, would go a long way toward improving the student loan crisis in the future:
- Access to Income-Based Repayment for ALL borrowers
- Deferment provisions for all student loans
- Reasonable interest rates and fees on federal loans
Any loans that do not meet these standards would be considered a higher risk loan and could then be eligible for discharge through official bankruptcy proceedings. As discussed earlier, the addition of bankruptcy options would force lenders to be much more cautious about who they made loans to, thereby putting into motion a cycle of lower-risk loans, an increased value of college degrees in general, lower tuition across the board, and reduced student loan amounts for borrowers. Implementing these few ideas would go a long way toward both preventing the student loan crisis from expanding further, and reducing it going forward.
As always, we will keep you up-to-date on the latest developments regarding student loan bankruptcy options and how they might affect your student loans in the future.