The 'Undue Hardship' of Student Loans

According to a 2012 NY Times article, the balance of federal student loans have increase by more than 60 percent in the last five years with many struggling to repay their loans. However, the grim reality is that unlike other debts, declaring bankruptcy cannot discharge student debt.

Regarding the now forbidding situation of student loans, things have not always been the case. Before the mid-1970s, people were able to discharge student loans in bankruptcy courts, just like you and I could today for car debt, auto loans, etcetera. However, Congress changed the law in 1976 as people took advantage of the system. That year the bankruptcy code was altered so that loans made by the government or a non-profit college or university could not be dismissed during the first five years of repayment.

Over the years, in 1990 and 1998 Congress in an effort to protect taxpayer money enacted even tougher laws regarding student loans. Most recently in 2005, for-profit companies that lent money to students got Congress to extend the same rules to these companies’ private loans. Today, no student loan whether federal or private, can be discharged in bankruptcy unless the borrower can prove that repaying the loan would cause ‘undue hardship,’ which typically involves convincing a federal judge that there is a “certainty of hopelessness” in one’s financial life for much of the individual’s repayment period. The benchmarks are set so high that unless an individual has severe disability, it’s unlikely that one would be able to make a case to discharge his or her student debt. Hence, this basically means that like child support debt and criminal fines, student loans essentially cannot be discharged.

The truth is, the process for discharging student debt is so convoluted that as Rob Lieber, the Your Money columnist for the NY Times, wrote, “No one keeps track of how many people bring undue hardship cases each year, but it appears to be under 1,000, far less than the number of people failing to make their student loan payments.” Additionally, he makes the case that many who may qualify to have their loans discharged “generally lack the money to hire a lawyer or the pluck to file a suit without one.”

Nonetheless, most people are actually fine with the fact that individuals cannot discharge federal loans, since the government is the one backing these loans and it has rather lenient repayment options. Of course, for private loans that’s a different story. Fees charged are often higher and repayment options are not as lenient. Mark Kantrowitz, publisher of the FinAid and Fastweb web sites, noted this as an issue that needs to be addressed and said, “Too many people are struggling with no light at the end of the tunnel. They are basically stuck in purgatory their entire life, just because they made a mistake and borrowed too much money.”

Additionally, some people have compared the issue of excessive student borrowing to that of risky mortgages. A 2012 Forbes article noted 5 reasons the student loan crisis is nothing like the mortgage crisis. The main reasons being:

1. The size of the student loan market is much smaller than that of mortgage debt.
2. 85% of student loans are backed directly by the U.S. government; hence the private loan market is small.
3. “False assumptions” are not feeding the student debt crisis as compared to the mortgage crisis.
4. You really can’t get rid of student loans by declaring bankruptcy.
5. People are watching the student loan crisis. “People see this one coming.”

Without doubt, growing excessive student debt is an issue, but will allowing students to discharge their debt in bankruptcy courts really relieve the problem? Some people have argued that allowing students to discharge private loans may induce students to take on loans during college, get a diploma, then turn around and file for bankruptcy, which will in turn cause more chaos. Other argued that allowing these loans to be discharged might have very positive effects. Lenders will be more cautious of who they lend to and set up more lenient terms. Young people will also then be more financially flexible to spend on big-ticket items, such as cars and houses, which in turn should bolster the slow economy.

Compare home equity rates where you live.