Are Big Changes Coming to Student Loan Bankruptcy Rules?

u.s. bankruptcy court

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Student loans are for life. Unlike virtually every other type of consumer debt – car loans, credit card debt, medical bills – you can’t escape from educational debt by declaring bankruptcy. At least, that’s the conventional wisdom. Recently, however, there have been some signs that it might eventually get a little easier for people who are burdened by unmanageable student loans to find relief through the bankruptcy process.

A handful of federal judges who handle bankruptcy cases have indicated they think the current standard, which only permits educational debt to be discharged if it is causing the borrower “undue hardship,” needs to be reconsidered, the New York Times reported. One, Jim D. Pappas, a judge in the U.S. Bankruptcy Court’s Idaho District, noted in a 2013 opinion the current method of determining whether student loans are too burdensome “is too narrow, no longer reflects reality and should be revised…a bankruptcy court should be afforded flexibility to consider all relevant facts about the debtor and the subject loans.” He’s not alone in his concerns, and several other bankruptcy court judges have expressed their concerns over they way these cases must be handled.

Currently, judges usually apply what is known as the “Brunner test” when determining whether a person’s student loans qualify as an undue hardship. To pass the test, a borrower’s loans must prevent them from maintaining a reasonable standard of living, their financial situation must be unlikely to change in the future, and they must have made a good-faith effort to repay their debt. That, as many borrowers have discovered, is a very high bar to meet.

college graduation

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“As it stands now, a debtor needs to show some disabling infirmity or condition of utter hopelessness in order to discharge student loan debt,” explained Michael B. Kaplan, a bankruptcy judge for the district of New Jersey, in an article for American Banker. Kaplan supports rethinking the way student loans are treated in bankruptcy proceedings, arguing that it would be “better for the country and the economy as a whole” if it were easier to discharge student loans in certain situations.

Take the case of Mark Tetzlaff, a 56-year-old man who ended up with $260,000 in student loan debt. Some of that was money he borrowed to pay for a law degree, though he was ultimately unable to pass the bar exam, WisBar News reported. Tetzlaff was an unemployed, suffered from alcoholism and depression, and lived with his elderly mother, who supported them both with her Social Security payments. On the surface, it seems like he’d have no trouble meeting the undue hardship standard.

Tetzlaff argued that his debt should be discharged, in part because his health problems and misdemeanor criminal convictions meant he couldn’t find a job. The U.S. Court of Appeals for the Seventh Circuit disagreed, noting that there was no “certainty of hopelessness” in Tetzlaff’s situation and that considering his “academic degrees, prior work experience, and age…he is capable of earning a living.” (Also worth noting: The judges suspected that Tetzlaff may have been “feigning [the] psychological symptoms” he claimed were preventing him from finding work.)

Tetzlaff is hardly the only person who has tried and failed to shed their student loan burden. In June 2015, a federal judge ruled that a disabled woman earning roughly $10,000 a year still had to repay roughly $37,000 in student loans. She failed the Brunner test because she hadn’t made a good-faith effort to pay back her debt, Bloomberg reported.

student loan repayments

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The strict rules about wiping away student loan debt made some sense in the past. Until 1998, student loans could be discharged in bankruptcy provided that the borrower had been repaying the loan for at least seven years. People who wanted to discharge student loans before hitting the seven-year mark needed to meet the “undue hardship” requirement. But now all student loan borrowers seeking bankruptcy protection must meet that standard, regardless of how long they’ve been paying back their debt. At the same time, the amount of student loan debt has exploded, so more people are finding themselves saddled with big loans and no way out if their financial situation is bad.

In an attempt to address the issue, the White House is also taking a serious look at changing the rules about student loans and bankruptcy. In March 2015, President Obama instructed officials to review bankruptcy procedures for educational borrowers. Following that announcement, a number of Democratic senators introduced the Fairness for Struggling Students Act, which proposes allowing certain private student loans to be discharged in bankruptcy (something that was permitted as recently as 2005).

Any change to how student loans are treated in bankruptcy is likely to be slow in coming, though. In the meantime, struggling borrowers may need to look elsewhere for relief. People with very low incomes may benefit from pursuing income-based repayment plans. Someone with an income at or below 150% of the poverty line will have a monthly payment of $0, and any remaining loan balance will be discharged after 25 years. Temporary economic hardship deferments and loan forgiveness programs for people working in public service may help some other borrowers manage their debt.

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Even with the high standard that must be met, some people do succeed in having their student loans discharged in bankruptcy. Forty percent of people who sought a hardship discharge for their student loans received one, a 2011 paper published in the American Bankruptcy Law Journal found. Those who succeeded were more likely to be low-income and have a medical condition that affected their ability to repay their debt. Yet the vast majority of people (just 0.1%, according to the study) with student loans never bother to seek such relief, perhaps because they believe their attempts will fail.

“Courts are willing to grant discharges,” noted Jason Iuliano, the paper’s author. “The problem is that few people are asking for them.”

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