Bankruptcy Law and Student Loans: Not a Working Relationship

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Under the current system, it is all but impossible to get student loans wiped out through bankruptcy, unlike most other forms of unsecured debt such as credit card and medical bills. Legal experts believe that this is creating a generation of Americans who are unable to get out from under the crushing weight of college debt.

If borrowers don’t have the money to repay their debt, and the debt is not dischargeable, they will never be able to participate in the credit economy. They are effectively, off the economic grid, and will never be able to put “new” money into the stream of commerce.

A substantial chunk of student loan debt has been a growing fact of life for many Americans. According to the Consumer Financial Protection Bureau, total student loan debt is nearing a whopping $1.2 trillion, which exceeds total credit card debt by more than 28 percent. Forty-five percent of American families now have student loans, according to a recent report released by the Center for American Progress. These studies and statistics showed the increase of student loans caused students to delay other significant life purchases like homes, cars, and even major life milestones like marriage and starting a family.

The idea that if you go to college, you’ll be able to get a job, and you’re on your way in life is no longer realistic. Because education has gotten to be so expensive, many people come out of college with $50,000 to $100,000 in student loan debt. This fact, in combination with high unemployment rates has relegated many graduates to a new, and potentially permanent underclass.

In bankruptcy, a borrower can wipe out most of his unsecured debt entirely (Chapter 7), or repay a portion of it over three to five years (Chapter 13). This gives what bankruptcy practitioners and courts have called a “fresh start.”

But the ability to discharge student loans in bankruptcy has been whittled away over the years to the point where now the borrower has to prove that any student loan, even a privately issued one, would cause an “undue hardship” to them in order to get it discharged. Whether a debtor can prove this or not may depend completely on which state the debtor lives in, as the Supreme Court has not provided guidance on what the standard means, and courts interpret it in different ways.

Experts have proposed a number of fixes that would help out borrows stuck under unmanageable debt burdens. Some have proposed allowing all private loans to be dischargeable. Another possibility that has been mentioned by bankruptcy law experts is allowing bankruptcy courts to value a debtor’s student loan at its fair market value, which is what another investor would be willing to pay to buy the loan off the original lender, and discharge anything above that value. A similar process is currently available to some debtors on their mortgages in bankruptcy.

But given the enormity of the student loan problem, even experts who propose bankruptcy reform think other issues must be addressed to control costs and make student loans a good bargain for young borrowers.

Posted in Chapter 13 Bankruptcy