Why Can’t You Discharge Student Loans in Bankruptcy?

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If you’re struggling to pay credit card debt, car loans or even gambling debt, you can wipe the slate clean in bankruptcy. Struggling to pay your student loans? Sorry, you’ll just have to figure that one out on your own.

In an effort to shed light on a policy they say “doesn’t make any sense,” a group of bankruptcy lawyers issued a report on Tuesday that highlights the need to change the U.S. bankruptcy code so that it offers college grads relief from inescapable debt loads. In the report from the National Association of Consumer Bankruptcy Attorneys (NACBA), four out of five of the 860 lawyers surveyed said the number of potential clients they encounter with student loan debt has “significantly” or “somewhat” increased over the past 3 to 4 years.

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It’s no surprise that student loan debt is a major concern. Federal and private student loan debt surpassed credit card debt for the first time in 2010 and is expected to hit $1 trillion this year. At the same time as college graduates are experiencing record-high debt, they are offered little opportunity to get back on track. “There’s no way to diffuse the bomb if the status quo stays the same,” NACBA Vice President John Rao said in a press call with reporters.

Which is why the group is calling on Congress to pass legislation that would allow graduates to discharge loans they took out from private lenders, including for-profit companies like banks and student loan giant Sallie Mae. Similar legislation has been submitted over the past two years by Democrats without making much progress, but nevertheless, NACBA is hoping this year will be different.

Changing the nation’s bankruptcy code wouldn’t just give the group of lawyers more work, it would offer an option for students to get rid of debt that, at its core, is not really any different from other types of debt that the government does allow borrowers to discharge. “It’s kind of strange that credit cards are dischargeable when private student loans aren’t,” said Mark Kantrowitz, publisher of the financial aid websites, Fastweb.com and FinAid.org. “They should be treated the same.”

They used to be. Before 1976, all education loans were dischargeable in bankruptcy. That year, the bankruptcy code was altered so loans made by the government or a non-profit college or university could not be discharged during the first five years of repayment. They could, however, be discharged if they had been in repayment for five years or if the borrower experienced “undue hardship.” Then, the Bankruptcy Amendments and Federal Judgeship Act of 1984 made it so all private student loans were excepted from discharge too.

Two decades of further tweaks to the bankruptcy code ensued until 2005, when Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which made it so that no student loan — federal or private — could be discharged in bankruptcy unless the borrower can prove repaying the loan would cause “undue hardship,” a condition that is incredibly difficult to demonstrate unless the person has a severe disability. That essentially lumps student loan debt in with child support and criminal fines — other types of debt that can’t be discharged.

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Many people are OK with the fact that graduates can’t discharge federal student loans. After all, the government is the backer on those loans (and therefore would be out the cash) and federal loans have a lot of options for repayment such as Income Based Repayment and loan forgiveness programs that give borrowers more realistic options for repayment and a way out. Private loans are a different story. Basically, the only option with private loans is to repay them — and to repay them on the lender’s timetable. They do not allow deferment or income-based repayment. Extensions often don’t lower the monthly payments by much and, while they do allow forbearance, they often offer much shorter terms and sometimes charge fees. “There is a genuine problem here that needs to be addressed,” Kantrowitz said. “Too many people are struggling with no light at the end of the tunnel. They are basically stuck in purgatory their entire life, just because they made a mistake and borrowed too much money.”

Some fear allowing graduates to discharge their private loans would create a situation where students take out many loans during college and then turn around and file for bankruptcy when they get their diploma. But those who make that argument forget that bankruptcy is not for the faint at heart; it’s a lengthy, complicated legal process and there are also anti-abuse protections in place to guard against those who would opt for bankruptcy when they can in fact afford to pay their debts.

On the contrary, Kantrowitz says allowing private loans to be discharged could have some very positive effects. Lenders might be more careful about whom they lend to and how much. And when they have distressed borrowers, they might be more willing to compromise, he says. Which would mean for the first time in a long time, private lenders would have a little incentive to play nice with students.

Kayla Webley is a Staff Writer at TIME. Find her on Twitter at @kaylawebley, on Facebook or on Google+. You can also continue the discussion on TIME’s Facebook page and on Twitter at @TIME.

6 comments
Socialmedic
Socialmedic

That's great, punish the people who have 150,000 in government loans for going to Harvard, but reward the ditz who runs up 150,000 on credit cards satisfying her shoe fettish.  I am sure more and more people are going to be willing to study and work hard under such a reward system.  The work ethic and motivation of Captialism is everywhere present except when it comes to education and the nation's brightest who are not born to rich families, no doubt because THAT is the greatest threat to the status quo!  After all what would the nation's richest do if they actually had to COMPETE in school and in life with the brightest of the nation's poor????????

Indentured
Indentured

Im currently looking at my options. Art Institute, with their non-accredited degree, cost me about 75k, which ballooned up to 100k. Since I was young, and didn't fully understand amortization, I got horrible interest rates... 

Sallie Mae wants me to pay about 1200 a month. I can only afford 600, which I have been paying for 3 years, but thats ONLY the interest...

-They dont allow consolidation of private loans,
-I dont qualify for the wage percentage repayment,
-My job is full time with unpaid overtime, a second job is out of the question.
-Sallie Mae wont negotiate the value of the loan, or interest rates.
-Bankruptcy doesn't eliminate, stop interest, or even put the payments to something reasonable.

So what options do I have? 
Pay interest for eternity and just never own anything?
Fake my death, Flee the country and create a new identity?

supraman215
supraman215

Disgusting. Why not the ability to discharge all loans? If people abuse them raise the interest rates. Causing fewer people to be able to afford them, lowing the cost of admission. The whole problem with the increasing cost of education is cheap government loans. This article doesn't even touch on that. It should be illegal to make a loan where the penalty for non payment is imprisonment, that's the crime. That's enslavement. 

JoshuaCrowley
JoshuaCrowley

@Socialmedic

Your example loses steam because the person buying the $150,000 worth of shoes should not have been extended such a large credit line if they couldn't pay it back. That is the lender's fault and they assume that risk when handing out those credit cards. Similarly, someone who could not viably afford to pay back $150,000 for Harvard should not be able to attend Harvard... same as with a mortgage.. they should be vetting you and refusing for a million dollar home you can't afford.

The only reason one gets that chance to go to Harvard is because these loans are non-dischargeable, but the comparisons you are making are apples and oranges. The credit card example is a private lender who knows the associated risk and takes the hit when bankruptcy comes. In the education example, the lender is at no risk, and all the risk lies in the burden of the holder due to non-dischargeability. This still negates your argument about competitive education, because if your remedy is student loan dischargeability... the lender never would have loaned someone $150,000 for school if they couldn't show adequate proof/viability that they could pay it back, fearing the person might claim bankruptcy.

What I'm basically saying is don't let null comparisons of stupidly high lending be your argument. The elites, from your example, wouldn't fear us because once student loan dischargeability happens (and loan amounts are reduced to the masses because lenders check your income viability to repay), the elites will still be the only ones affording Harvard. Your anger seems to lie misplaced...it assumes that over-extended lines of credit/loans are a GIVEN, and you are angered that one over-extended credit should be equal to another over-extended credit. The main problem is the over-extension of the credit moreso than dischargeability. But the only way to make lenders stop over-extending credit is to make loans dischargeable- and income will be factored into loan amount lended- the same as it is with other types of loans. We agree on the solution, I just think you're not using correct reasoning to plead your case and also not seeing that their will also be negative side affects to accessibility to higher education by the middle class when student loan dischargeability actually comes.