Can Student Loans Be Cleared By Bankruptcy? 4 questions answered

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(THE CONVERSATION) For decades, most student loans have been banned from being discharged through bankruptcy proceedings. This could change under the NEW START thanks to the Bankruptcy Act. Here, public policy scholars Brent Evans and Matthew Patrick Shaw, both of Vanderbilt University, discuss why student loan debt typically cannot be settled through bankruptcy, and how that might change if the proposed bill becomes law.

Why Can’t People Get Rid of Student Loans Through Bankruptcy Now?

While it is not impossible, it is difficult to pay off student loans in bankruptcy. Because of a law of 1976, student loans are not treated in bankruptcy like other forms of debt, such as credit card debt or car loans. This policy stems from a Federal Commission on Bankruptcy Laws, who heard testimony that the easy release of student loans in bankruptcy could undermine federal student loan programs. Congress was concerned that students would borrow thousands of dollars from the federal government, graduate, file for bankruptcy so their student loans would be canceled, and never pay off student debt.

As an extension of the Higher Education Act 1965, Congress adopted the 1976 law, which required borrowers to wait five years after the first student loan payment was due before they could cancel the loan through bankruptcy. Congress created an exception that allowed release during that five-year period if the loan caused “undue hardship.”

Congress extended the bankruptcy ban from five years to seven years in 1990. Then Congress extended it to the life of the borrower by 1998.

Currently, the “undue hardship” exemption is the only way to get discharge from student loans in bankruptcy – it’s a much higher threshold than many other common forms of debt. This higher threshold includes both federal student loans and, since 2005, most forms of private student loans.

Weren’t there cases where people got rid of their student loans again by going bankrupt?

Absoutely. Although difficult, it is still possible to have student loans discharged through bankruptcy by meeting the undue hardship requirement. A 2011 study found that only 1 in 1,000 student loan borrowers who reported bankruptcy even tried to have their student loans canceled. However, those who succeeded at a rate of 40%.

Article 523 of the Bankruptcy Code does not establish a specific test for determining what constitutes undue hardship. Federal courts are divided on what the appropriate standard should be for paying off student loan debt. The case of the second circuit, Brunner v. New York State Higher Education Services Corporation, established three requirements that determine whether undue hardship applies.

First, the borrower must demonstrate that if he is forced to repay student loans, he will not be able to achieve a minimum standard of living based on his income and bills.

Second, the borrower must be unable to repay for a “significant part of the repayment period”.

Third, they must have made good faith efforts to repay the student loan.

If a bankruptcy court agrees that a borrower meets all three of these conditions, the court can discharge the student loan debt.

But the bankruptcy courts in the Eighth circuit (in the Upper Midwest) – and sometimes courts in the First circuit (in Puerto Rico and parts of New England) – reject Brunner and look at “the totality of the circumstances” instead.

For example, the case of 2003 In D Long states that a borrower can meet the undue hardship requirement in a different way than Brunner. The borrower must establish that he cannot achieve a minimum standard of living given the financial resources, necessary living expenses and other circumstances.

This test is considered less difficult to complete than Brunner because it does not require a borrower to establish a “certainty of hopelessness” or “total incapacity”.

Explain the proposed law to authorize bankruptcy for student loans

If adopted, the bipartite NEW START thanks to the Bankruptcy Act would amend the current law to remove the lifetime ban on student loan discharge in bankruptcy and replace it with a 10-year ban.

Under the proposed law, if borrowers can prove that paying their student loans caused undue hardship in the first 10 years, then they can be released after that 10-year period has ended without having to prove. that it would be undue hardship on that part. point forward.

This change would only apply to federal student loans, not private student loans. Any release from private student loans, regardless of the repayment schedule, would always require proof of undue hardship.

To help meet some of the financial cost to the federal government of this proposed change, the bill also includes an accountability measure for colleges and universities. Schools would have to repay the government a portion (either 50%, 30%, or 20%) of the released student loan amount based on the cohort default rate and the institution’s repayment rate at the time of the first payment of the loan. loan matures.

Would Bankruptcy Become an Attractive Way to Get Rid of Student Loans?

Declaring bankruptcy is not an ideal option for dealing with student loans, as it has significant immediate and long-term consequences. The immediate consequence is that bankruptcy can result in the sale of property to pay off debts. The longer term consequence is that, depending on the type, Chapter 7 or 13, bankruptcy stays on credit reports for seven to 10 years. The substantial negative mark on credit reports means that it will be more difficult to get a credit card, a car loan, and a mortgage. When some form of credit is obtained, the interest rates are likely to be much higher with bankruptcy on file.

Another solution to large student debt is to enroll in a income based repayment plan, such as Review compensation as you earn. These plans limit the monthly payment amount on federal student loans to a percentage of your discretionary income, which is the difference between your income and 150% of the state’s poverty line, adjusted for family size.

After 20 years of repayment for undergraduate loans (only 10 years if the borrower is employed in the civil service), the remaining balance is written off. If the new bill becomes law, borrowers with income-based repayment plans will have a choice. They can either sue for bankruptcy after 10 years and suffer the consequences, or continue to pay with a forgiven loan.


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