Bankruptcy Legislation Being Considered to Discharge Student Loan Debt

As Congress and the White House move to alter the bankruptcy code to make it more equitable to consumers, a House subcommittee began a reconsideration recently of how bankruptcy law treats private student loan debt.


Rep. Steve Cohen, chair of the House Judiciary Subcommittee on Commercial and Administrative Law, held a hearing to initiate legislation reversing a 2005 change in federal bankruptcy law that, he said, gave private student loan lenders a “favorable, unusual” advantage over borrowers, as well as in comparison to the issuers of most other kinds of consumer loans. "Hopefully it’ll be bipartisan and if not, you know, we’ll just have to forge ahead and do what’s right.”

After the hearing, he announced plans to file legislation to “give private student loan borrowers more equitable treatment during the bankruptcy process.”

Rep. George Miller, chairman of the House Education and Labor Committee, hailed the drafting of new legislation as meeting “a growing need to protect students from financially riskier private student loans and predatory lending practices,” especially with rising college costs and an unemployment rate approaching 10 percent.

The subcommittee’s senior Republican, Rep. Trent Franks of Arizona, seemed receptive to some reform of the private student loan industry, but cautioned that if the bill passed last week “isn’t the death knell of private student lending, ending the favorable treatment student loans receive under bankruptcy code certainly could be.”

Bankruptcy law bars virtually all borrowers from discharging their private student loan debt, even as most other forms of consumer debt -- including auto loans, credit card debt and mortgages -- can be discharged through bankruptcy proceedings. The only exceptions are made in cases of “undue hardship.”

Though federally guaranteed student loans usually can’t be discharged in bankruptcy cases either, they do come with fixed interest rates, flexible payment plans and other consumer protections that generally make them less onerous for borrowers. Private student loans are one of the riskiest ways to pay for college. Those loans are not financial aid any more than using a credit card to pay for tuition or books are financial aid.

Even so, students are turning to the loans to make up the gap between federal student loans (which top out at $12,500 per academic year for independent undergraduates in the last two years of study) and the ever-rising costs of tuition and fees at American colleges and universities. According to calculations by Asher’s organization, two-thirds of all graduates of four-year colleges have student loans, averaging $23,200 in federal and private loans, and a third of students who earned a bachelor’s degree in 2007-8 took out a private student loan during their time in college. Fourteen percent of all U.S. undergraduates took out a private student loan in that academic year, up from 4 percent in 2003-4.

Facing Bankruptcy

Over the course of earning a bachelor’s degree, a student at a particularly pricey institution receiving little or no grant aid could end up borrowing $100,000 or more in private loans. It appears unfair to some people that other loans of that magnitude, like mortgages, to be forgiven in bankruptcy proceedings while student loans are not.

Defining 'Undue Hardship'

The only chance borrowers have to discharge their private student loans during bankruptcy proceedings comes by being able to demonstrate “undue hardship,” a term that has not been concretely defined by Congress and is up for varied interpretations by bankruptcy judges.

Courts generally go through long investigations to determine whether debtors have faced exceptional challenges, such as physical or mental disabilities, a lack of job skills or an absence of future earning potential. Final rulings are up to the discretion of judges, Asher of the Institute for College Access and Success said, and much more likely to happen with the benefit of “a high-priced attorney.”

All four experts who testified voiced support for Congress to create its own definition of “undue hardship,” which could be easily used to evaluate all bankruptcy cases involving student loans. Democrats and Republicans on the subcommittee were all receptive to the formulation of a definition.


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By: Attorney Robert Schaller (Bob's bio) of the Schaller Law Firm

Bob is a member of the National Bankruptcy College Attorney Network, American Bankruptcy Institute and the National Association of Consumer Bankruptcy Attorneys.

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