Omar Bennett
The persistent myth that student loans cannot be discharged in bankruptcy is untrue. While it is more difficult to discharge student loans than other types of unsecured debt, it is not impossible. The undue hardship requirement, which was passed into law in the 1970s, poses a significant barrier for borrowers, who must also undergo an adversary proceeding, essentially a lawsuit within the bankruptcy process. However, some loans that borrowers may consider private student loans are not subject to this standard and can be discharged in a typical bankruptcy proceeding. Recent reforms, such as the Biden administration's new student loan bankruptcy policy, are making it easier for borrowers to obtain relief, with 99% of cases resulting in full or partial discharge.
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What You'll Learn
The myth of student loan bankruptcy discharge being unconstitutional
For years, a myth has persisted that student loans cannot be discharged in bankruptcy. This is not true. While it is more difficult to discharge student loans than other types of unsecured debt, it is not impossible. The myth that student loans are not dischargeable in bankruptcy is perpetuated by student loan companies, which often fail to give borrowers the information and support they need. Some companies may even be making false statements to borrowers about the protections bankruptcy offers.
The myth that student loan bankruptcy discharge is unconstitutional may stem from the “undue hardship” requirement, which is a major barrier for most borrowers. This requirement was passed into law in the 1970s due to fears that students would file for bankruptcy upon graduation to be relieved of their debts. However, there is no evidence that students were doing this in significant numbers. The "undue hardship" standard is notoriously difficult to meet, as it requires borrowers to demonstrate how paying their student loans impacts their living expenses and financial stability.
Additionally, some borrowers may not realize that discharge is still possible even with the "undue hardship" requirement. For example, some private loans for educational purposes can be discharged in a normal bankruptcy proceeding, just like most other consumer debts. Non-qualified private student loans, which are not certified by the school, are also automatically discharged under the bankruptcy code.
Recent reforms have made it easier for borrowers to seek debt relief through bankruptcy. The Biden administration's updated policy treats student loans more like other types of debt in bankruptcy court. Borrowers can now fill out a 15-page form detailing their financial struggles and making their case for a discharge. While bankruptcy can provide much-needed relief for debt-burdened consumers, most borrowers should look for other relief options first, as bankruptcy can have long-lasting impacts on an individual's credit report.
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The Brunner Test and other legal standards
The Brunner Test is a legal test used by most bankruptcy courts to determine whether an individual qualifies for student loan forgiveness. The test is based on three factors:
- The individual cannot maintain a minimal standard of living for themselves or their family if forced to repay their loans. The court will review income and expenses for verification, including basic needs such as rent, food, utilities, and car expenses.
- Their current financial situation is unlikely to change during the repayment period.
- They have made a good-faith effort to repay their loans.
The Brunner Test has been criticised for not distinguishing between honest and dishonest debtors, and for preventing those in genuine financial crisis from discharging their student loans. For example, under the Brunner Test, individuals who have defaulted on their student loans due to disability or illness may be denied discharge.
While most courts use the Brunner Test, it is not the only standard applied. The Eighth Circuit, for instance, uses a totality of the circumstances approach ("Totality Test"), which takes into account the unique facts and circumstances of each bankruptcy case. This includes considering the debtor's past, present, and reasonably reliable future financial resources, as well as their necessary living expenses.
The First Circuit has yet to declare a standard, but it is worth noting that some courts will also look at the totality of the circumstances in these cases.
In addition to passing one of these tests, borrowers must also file for either Chapter 7 or Chapter 13 bankruptcy, depending on their financial situation, and meet the undue hardship requirement, which is a major barrier for most.
Despite the challenges, recent reforms and legal actions are making it easier for borrowers to seek debt relief through bankruptcy, and bankruptcy courts are becoming more likely to discharge loans.
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The role of the Biden administration in easing bankruptcy discharge
While serving as a senator, Joe Biden supported a bill that made it harder for borrowers to discharge their student loans through bankruptcy. In 2005, Biden, then a senator, backed a bill that stripped students of bankruptcy protections, making it harder for borrowers to get relief. This law, known as the Bankruptcy Abuse Prevention and Consumer Protection Act, made it significantly more difficult for former students to discharge their debts and start over financially.
However, as president, Biden has taken steps to ease the burden on student loan borrowers and make it easier for them to seek debt relief through bankruptcy. The Biden administration has introduced a new student loan bankruptcy policy that treats student loans more like other types of debt in bankruptcy court. This policy has made it easier for borrowers to demonstrate financial need and a good faith effort to repay their loans, which has resulted in a higher likelihood of loan discharge.
The updated policy has been well-received by attorneys, who have noted its positive impact on borrowers. According to Malissa Giles, a consumer bankruptcy lawyer in Virginia, "We have gotten forgiveness for a number of clients under the new bankruptcy changes... The discharge is life-changing for them and their families."
In addition to the new bankruptcy policy, the Biden administration has also explored other avenues to address the student loan debt crisis. President Biden initially proposed cancelling up to $20,000 in student debt, but this plan was struck down by the Supreme Court. Despite this setback, the administration remains committed to finding solutions, with Richard Cordray, the head of the federal student aid office, promising to reform the bankruptcy process and ensure that borrowers in need can access relief.
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The impact of bankruptcy on credit reports and future financial opportunities
Bankruptcy is a legal process that offers relief to individuals who are unable to meet their debt obligations. While it can be a pathway to a fresh start, it also has serious consequences, including a negative impact on credit reports and future financial opportunities.
The impact of bankruptcy on credit reports:
When an individual files for bankruptcy, it is reported to credit bureaus and results in a significant drop in their credit score. This negative mark can remain on the credit report for up to 10 years, depending on the type of bankruptcy (Chapter 7 or Chapter 13). During this time, the individual may face challenges in obtaining new credit, including credit cards, personal loans, or mortgages. The availability of new credit may be limited, and if approved, the individual may face higher interest rates and unfavourable terms.
The impact of bankruptcy on future financial opportunities:
Bankruptcy can affect insurance rates, housing applications, and even employment opportunities. It may also impact an individual's sense of self-worth due to the social stigma associated with financial distress. Additionally, bankruptcy can result in the loss of assets, as certain properties or vehicles used as collateral may be seized.
It is important to note that the impact of bankruptcy on credit reports and future financial opportunities is not solely negative. Bankruptcy can provide a financial reset, stopping aggressive collection efforts and offering a chance to rebuild credit over time. Seeking guidance from credit counselling agencies or bankruptcy attorneys can help individuals understand their options and make informed decisions about their financial future.
While student loans have a reputation for being challenging to discharge in bankruptcy, it is not impossible. Recent reforms and updated guidelines have made it easier for borrowers to seek relief, particularly for federal student loan borrowers. The availability of bankruptcy relief for student loans depends on various factors, including the type of loan (federal or private), the borrower's financial situation, and the ability to demonstrate "undue hardship."
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Loan relief options outside of bankruptcy
Student loans are treated differently from other kinds of debt in bankruptcy. While bankruptcy can provide relief for debt-burdened consumers, it is not the only option for those struggling with student loan repayments. Here are some loan relief options outside of bankruptcy:
Debt Settlement
Debt settlement is a process where debtors negotiate with their creditors to pay back a portion of their debt and have the rest forgiven. This option can provide a middle ground between full repayment and bankruptcy, but it carries substantial risks that should be carefully considered. Debt settlement companies often charge high fees and may not always deliver on their promises, so it is important to research these companies thoroughly before engaging their services.
Debt Consolidation
Debt consolidation involves taking out a new loan to pay off multiple existing debts. This can simplify the repayment process and reduce overall interest costs, especially if the new loan has a lower interest rate. However, it is important to consider the costs associated with consolidation loans, such as origination fees or prepayment penalties.
Balance Transfers
Balance transfers involve moving high-interest credit card debt to a new card with a lower or 0% introductory interest rate. This can provide temporary relief by lowering interest payments, but it typically requires good to excellent credit and may come with transfer fees.
Refinancing
Refinancing involves replacing an existing loan with a new one that has more favourable terms, such as a lower interest rate or extended repayment period. This can help lower monthly payments and make the loan more affordable, but it may also extend the repayment timeline, resulting in higher overall interest costs.
Hardship Programs
Some lenders offer hardship programs that allow borrowers to temporarily skip or reduce their payments during difficult financial times. These programs are typically offered by lenders for secured debts, such as car or home loans. It is worth contacting your lender directly to inquire about any available hardship programs.
Credit Counseling
Credit counseling services provide professional financial guidance to individuals struggling with debt. Non-profit and for-profit organizations offer these services to help assess financial situations, develop personalized repayment plans, and improve financial management skills. Credit counseling can be a valuable tool to regain control of your finances and avoid more drastic measures like bankruptcy.
It is important to note that the availability and effectiveness of these options may vary depending on the type of student loan (federal or private) and the individual's financial situation. Exploring these alternatives can provide borrowers with much-needed relief without resorting to bankruptcy, which can have long-lasting negative consequences on credit scores and future financial opportunities.
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Frequently asked questions
No, this is a myth. While it is more difficult to discharge student loans than other types of unsecured debt, it is not impossible. Some borrowers may not realize that discharge is still possible even under the “undue hardship” standard and an extra step in the process ("an adversary proceeding").
Policymakers have added extra stipulations for the discharge of student loans in bankruptcy amid concerns that students would rack up debts and then try to ditch their obligations. The “undue hardship” requirement, which is notoriously difficult to meet, was passed into law in the 1970s due to these fears.
The Brunner Test is the standard used by most bankruptcy courts to determine whether a borrower has met the "undue hardship" requirement. It requires borrowers to demonstrate how paying their student loans impacts their living expenses and financial stability.
Recent reforms, including new guidelines from the Biden administration, have made it easier for borrowers to seek debt relief through bankruptcy. The new guidelines treat student loans more like other types of debt in bankruptcy court, and the government is now more likely to agree to discharge when the borrower can show financial need and a history of good faith efforts to pay the loans.
