Should Student Loans Be Dischargeable In Bankruptcy?
Whatever happened to the American dream of going to college, landing a great job and living happily ever after? College is supposed to be about getting off to a great start. However, as the cost of education and student loan debt continue to rise at alarming rates, college has become a financial noose that threatens to strangle students and the aging and unwary parents who co-sign for the student loans.
Student loan debt now exceeds $1 trillion and has surpassed credit card debt. There are two types of student loans: federal and private. Federal student loans have fixed and lower interest rates than private loans. Private student loans, on the other hand, often have high, variable interest rates, hefty origination fees and a lack of repayment options. And private lenders have targeted low-income borrowers with some of the riskiest, highest-cost loans.
Not only is student loan debt at all time highs, but there has been a sharp increase in the rate at which borrowers are defaulting. After a borrower defaults, the government has collection powers far beyond those of most creditors. The government can garnish a borrower’s wages without a judgment, seize tax refunds, seize federal benefits such as social security, and deny new education grants or loans.
Additionally, both federal and private student loans are among the few unsecured debts that generally cannot be discharged in bankruptcy. Student loans can only be discharged if the borrower can show that payment will “impose an undue hardship on the debtor and the debtor’s dependents.” “Undue hardship” seems like an easy hurdle to clear. If you are broke, the choice may be buying food or paying on the student loan, right? Unfortunately, courts have taken a very narrow and hard-line approach in construing the undue hardship standard. Consequently, it is very difficult to discharge student loans in bankruptcy.
A good example of this is found in the case of Wallace v. Educational Credit Management Corp., (Bky.S.D. Ohio Dec. 1, 2010). In this case, Wallace was diagnosed with diabetes with $32,500 in student loan debt. He only worked for one year after graduation and never earned over $12,000. He became blind and was forced to leave the workforce due to his diabetes. Wallace was forced to undergo dialysis, kidney and pancreas transplants. He was living on $811 per month in social security disability. He lived with his father with $790 per month in expenses. He had no job after the first year of employment and the student loan balance increased to $38,000.
Wallace asked the bankruptcy courts in Ohio’s Southern District to consider discharging his student loans because he was simply unable to pay them and was reasonably certain that he would never be able to repay them in the future. The bankruptcy court began by observing that the following test is used to determine whether student loans impose an undue hardship:
- The debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for himself and his dependents if forced to repay the loans;
- Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
- The debtor has made good faith efforts to repay the student loans.
The court held that the first and third prongs of the test had been met, but it faltered when it came to the second prong. The court noted that the debtor had a college degree and that “his physical condition appears to have stabilized.” The court further stated that, with regard to this blind debtor, “it remains to be seen… whether he will find work or remain unemployed.” This meant it was possible that the debtor might someday be able to make payments, and therefore the second prong of the test had not been satisfied.
There is no easy fix to the evolving student loan crisis. At a minimum, the non-dischargeability provision for private student loans should be eliminated. It is hard to fathom any reason to allow private student loans to be treated differently from other types of unsecured debt. Exempting these loans from discharge is likely to cause even more harm for borrowers because there are no interest rate limits or limits on fees charged for private student loans or limits on the amount of credit that can be extended.
Additionally, it should be easier to discharge federal loans. Federal loans used to be dischargeable. Until 1976, all student loans could be discharged in bankruptcy. Until 1998, student loans could be discharged after a waiting period (of initially five years but later seven years after repayment was scheduled to begin). In 2008, multinational banks were rescued from bankruptcy by receiving trillions of dollars of taxpayer money. If bailouts are good enough for billionaires, student loan bankruptcy (which is far from a bailout), should be permitted for the average American.
In conclusion, debt has traditionally come from mortgages, auto financing, and credit card debt. Student loans are a relatively new debt burden that no other generation has had to deal with. Now, our young work force is leaving their educational studies with huge amounts of debt already strapped to their shoulders. Because student loan payments have become more than borrowers can afford, people are unable to save for retirement, buy a home, enter important fields like teaching and public service, or afford to start a family.