Discharging Student Loans in Bankruptcy: A Brief History

 September 1, 2019
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Discharging Student Loans in Bankruptcy

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While most types of debt can be wiped away in bankruptcy, student loans usually aren’t one of them. Except in rare cases of severe financial hardship, federal and private student loans are exempt from bankruptcy discharge. Even if you run into financial distress, you’re probably stuck with your student loans for life.

But this wasn’t always the case. Prior to 1976, student loans — though not as widespread as they are now — were treated like any other kind of debt in bankruptcy proceedings. And in fact, a bipartisan group of lawmakers are hoping to bring this consumer protection back with the Student Borrower Bankruptcy Relief Act of 2019.

Let’s take a closer look at how discharging student loans in bankruptcy was stripped away over the years, as well as what bringing it back could mean for borrowers.

History of discharging student loans in bankruptcy

Changes to student loan discharge through bankruptcy began in 1976, with legislation enshrining the new rules in 1978. That said, there probably weren’t a ton of borrowers struggling with burdensome student loan debt at that time, as average yearly tuition at a four-year college averaged just $2,917 per year in 1978, and only $1,397 per year at four-year public colleges for in-state students.

“The amount of student loan debt on an individual scale, as well as a national scale, at that time was nowhere near what it is today,” said Emily Stork, finance lawyer at Holland & Hart LLP. “Nonetheless, legislators began to raise concerns that students might abuse the ability to discharge their loans.”

Even though “multiple government studies found little evidence of this,” according to Stork, Congress passed the Bankruptcy Reform Act of 1978. This act said borrowers had to wait five years before their federal student loans were eligible for bankruptcy discharge, except in the case of undue hardship.

Over the next few years, Congress placed additional restrictions around student loans. In 1984, it passed the Bankruptcy Amendments and Federal Judgeship Act, which made private student loans mostly ineligible for discharge through bankruptcy.

The Crime Control Act of 1990 extended the waiting period for declaring bankruptcy with student loans from five years to seven years, and the Higher Education Amendments of 1998 added even stricter restrictions.

“In 1998, legislation was passed which eliminated the ability to discharge student loans at all, except in cases of undue hardship,” Stork said. “Note that by this time, student debt was much larger than in the 1970s, so part of the impetus for all of these changes may have been concerns about how much debt the government would have to eat with a more liberal discharge policy.”

Finally, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made it virtually impossible to discharge federal or private student loans through bankruptcy, no matter how long the borrower had been in repayment.

Proving undue hardship to wipe away student loans

Although student loans are largely exempt from bankruptcy discharge, there are rare cases when borrowers can get rid of debt this way. If you can prove repaying your loans would create extreme financial hardship, you might be able to get them wiped away through Chapter 7 or Chapter 13 bankruptcy.

But according to attorney Russell Knight, pursuing bankruptcy discharge for student loans is “a fool’s errand.”

“The only way that a court will allow you to discharge your student loans is if the bankruptcy court finds the loans to be an ‘undue burden,’” said Knight. “The definition [of undue burden] is so onerous that almost no one could meet it.”

Essentially, you’d need to pass the “Brunner Test,” which requires showing:

  • You can’t pay your student loans and still maintain a minimal standard of living,
  • This situation will last for a good portion of your repayment period, AND
  • You’ve made good faith efforts to pay the loan.

If you’ve got federal student loans, you’ll probably be instructed to apply for income-driven repayment, where your payment could be as low as $0, rather than apply for bankruptcy.

What the Student Borrower Bankruptcy Relief Act of 2019 proposes

The student debt crisis has been a hot topic of discussion this year, with several of the Democratic presidential candidates proposing large-scale student loan forgiveness.

U.S. Sens. Dick Durbin (D-Ill.) and Elizabeth Warren (D-Mass.), along with U.S. Reps. Jerrold Nadler (D-N.Y.) and John Katko (R-N.Y.), also introduced the Student Borrower Bankruptcy Relief Act in May, a proposal which would allow student loans to be treated like other types of consumer debt in bankruptcy proceedings.

“Filing for bankruptcy should be a last resort, but for those student borrowers who have no realistic path to pay back their crushing student loan debt, it should be available as an option to help them get back on their feet,” said Durbin when introducing the bill. “Our nation faces a student debt crisis, and it’s time to restore the meaningful availability of bankruptcy relief to student loan borrowers.”

Bankruptcy discharge might not address larger student loan crisis

Filing for bankruptcy is an expensive and difficult process that can wreak havoc on your credit. If passed, this bill would likely only impact a small number of student loan borrowers who have run into extreme financial problems.

According to Stork, greater changes are needed to truly address the student loan crisis and provide relief to borrowers.

“Millions of people can’t just plan to get a discharge in bankruptcy — it isn’t a real solution,” she said. “We need some kind of real student loan debt reform, not only to address existing student loans but also … future student debt to make sure we don’t have another generation of young people drowning in debt.”

While allowing bankruptcy discharge of student loans might help a handful of borrowers, larger steps would be needed to make meaningful change for the millions of people with student loans.