Student Loans And Bankruptcy

In recent years, higher education is seemingly necessary to get good paying jobs and be upwardly mobile in American society. Studies have shown that college graduates nearly earn double than their high-school graduate counterparts.

However, college is expensive and is becoming increasingly so. If scholarships are not available, the most popular way to finance college is through student loans. Unfortunately, as student loans are difficult to impossible to discharge in bankruptcy, they come with more obligations than other types of debt.

Student-Loan Statistics

According to the Federal Reserve Bank of New York, $870 billion in student loans are outstanding and about 37 million Americans have student loan debt. The average balance of a student loan is about $23,000.

Most student loans are federal. However, of the remaining 15 percent of student loans that are counted as private, most of the lenders receive funding from the government, with a very small percentage of loans coming from truly private lenders.

With the poor economy and depressed job prospects, more students and former students than ever are struggling to pay off their student loans. Only 39 percent of the loans are being paid off. About 5.4 million borrowers are behind on their student-loan payments.

Undue Hardship

Over the years, student loans have gotten harder to discharge. All student loans were dischargeable in bankruptcy until 1976. Between 1976 and 1998, students had to wait at least five years before they could wipe out their loan debts in bankruptcy.

Beginning in 1998, Congress made all federal student loans nondischargeable in bankruptcy, as it believed that it was too easy for students to walk away from their loans, leaving taxpayers on the hook.

In 2005, Congress made private student loans almost impossible to discharge. Congress acted to protect lenders from loss caused by discharged loans, as student loans are not secured by collateral (property that can be seized if loans are defaulted upon). In addition, by making it harder for students to discharge student loans in bankruptcy, lawmakers wanted to encourage lenders to lend to students.

Private student loans can be discharged in what are practically very rare circumstances. Under the Bankruptcy Code, a private student loan can be discharged if the loan would impose an "undue hardship" on the borrower. Courts have many definitions of what constitutes an undue hardship, but in most cases, the borrower must show:

  • That the borrower cannot maintain a minimal standard of living based on current income and expenses
  • That the borrower's dire financial situation is likely to continue for most of the loan's repayment period
  • That the borrower has made good-faith efforts to repay the loan

Since the borrower essentially has to prove that he or she cannot pay the loan and likely will never be able to, it is very difficult to show that the loan causes an undue hardship.

Although student loans are difficult to discharge in bankruptcy, most other debts do not carry the same restrictions. Debt-relief options such as Chapter 13 or Chapter 7 bankruptcies may allow you to restructure your other debt; however, unless approved by the Bankruptcy Court, you are not allowed to make any payments on your student-loan obligations until a discharge has been received.

If you are considering bankruptcy, it is important to contact an experienced attorney. A lawyer can review your current financial situation and advise you on the debt-relief options in your individual circumstances.