Should bankruptcy laws allow student loans to be dischargeable?

Written By: Ishaan Raja

Back in fifth grade, I ran a small lending business. It was meant for other kids who had forgotten their lunch money that day. I would buy them lunch, with the expectation they would pay me back the cost plus one dollar in interest the next day. Business was good until a loophole was discovered. I could not actually force anyone to pay their loan, and I could not take back the lunch they had already eaten. Although this lending practice was vastly different from how large banks operate, there are still some shared principles that would cause dischargeable student loans to have terrible consequences. 

There are two types of student loans that people can take out for education: federal and private. Private lenders often have strict requirements, and will adjust interest rates to mitigate their perceived risk on the loan. Unlike private loans, federal student loans have fixed interest rates and very relaxed qualifications. The Parent PLUS loan program, for example, allows students to take out almost unlimited amounts of credit as long as a parent co-signs (“Parent PLUS Loans”). 

It is clear that student debt is an incredibly large crisis in the United States. The total student loan debt is one and a half trillion dollars, and there is one hundred billion dollars worth of student loans in default (Friedman). Those who fail to pay can have their wages garnished, and if retired, social security benefits seized. Over eight hundred thousand retired Americans struggle with student loan debt (“Unpaid Student Loans: Can They Garnish Your Tax Refund to Collect?”). With these kinds of statistics, many have suggested that bankruptcy laws be changed to allow student loans to be discharged in bankruptcy, just like a home or car loan.

However, student loans are not like any other type of loan. Much like my lunch money lending business, a lender cannot repossess the underlying asset.  In the case of a Chapter 7 bankruptcy, the lender can repossess the car or home, sell it, and earn back some of the loan’s principal (“You May Be Able to Keep Your Home When Filing Bankruptcy”). However, lenders cannot repossess education procured on a student loan. Currently, discharging any loan in bankruptcy is a negative for the borrower; they could lose their home, car, or any other asset purchased with borrowed money. 

The nature of student loans makes them inherently a higher risk to lenders. Students take out loans to attend college with the goal of obtaining a higher paying job after graduation. The creditor is lending money to someone who currently lacks a stable income, but might obtain one after they complete their studies. Since this type of loan relies on future outcomes, it is very difficult to predict whether the student will be able to repay ahead of time. 

If a policy change allows student loans to be discharged in bankruptcy, then a student could effectively discharge a one hundred thousand dollar student loan and lose nothing but their credit score. Since credit scores only last for seven to ten years (Geffner), the student can wait, and their life will effectively return to normal without any student loan payment.

The impacts of such a policy change would be widespread. The risk of lending to students will rise dramatically. Creditors will lose millions of dollars as a result of bankruptcy discharges. The risk for the borrower is low, and any student that discharges their loan will lose close to nothing. 

The creditor that will hurt the most is the American taxpayer. The Department of Education uses federal tax money to fund student loans. If student loans are discharged, the American taxpayer will post a loss of hundreds of billions of dollars from the almost $1.2 trillion in outstanding loans in its portfolio (“Federal Student Loan Portfolio.”). 

This policy change would hurt low-income students the most. As federal PLUS loans are limited to the cost of attendance, these students may need to take out private loans to cover other costs such as living expenses. Private lenders will inevitably tighten eligibility to minimize risk and potential loss. Gauging risk for lending to students will still be difficult, but making them dischargeable in bankruptcy means lenders will inevitably tie loan eligibility to the only information they know: parental financial situations. This means that students who have parents with low credit scores, or come from families with lower incomes will suffer. 

There is a misconception that student loans cannot ever be discharged. This is not the case, a court of law can discharge student loans if they impose an “undue hardship” on the student (“Unpaid Student Loans: Can They Garnish Your Tax Refund to Collect?”). 

However, this process can be extremely lengthy and expensive. Requesting a discharge requires the borrower to file an adversary proceeding. Courts have incredibly rigid standards for undue hardship discharges, and creditors will often appeal the decision, prolonging the case for as long as possible (Minsky). The solution here is for Congress to amend the Federal Bankruptcy Code and create exact criteria for what qualifies as undue hardship. This would allow the courts to make a more objective decision when discharging student loans for undue hardship. 

This solution would safeguard both creditors and borrowers. Creditors will not have to fear losing millions of dollars due to lending money on an asset that cannot be repossessed and student borrowers can still discharge a loan if it truly imposes hardship as determined by the court and bankruptcy code. 

Allowing student loans to be discharged in bankruptcy will create a new crisis for matriculating students. Creditors will inevitably tighten eligibility requirements to minimize risk, thereby preventing low-income students from getting the funds they need to attend college. Student loans should not be dischargeable in bankruptcy, except in cases where the court agrees they impose an undue hardship. Instead, the bankruptcy code should be amended to provide exact standards for when student loans constitute an undue hardship on the student. This would safeguard both the American taxpayer and private lenders to ensure that higher education is accessible to all.

Works Cited

“11 U.S. Code § 523 - Exceptions to Discharge.” Legal Information Institute, Legal Information Institute, www.law.cornell.edu/uscode/text/11/523.

“Federal Student Loan Portfolio.” Federal Student Aid, Department of Education, 19 Feb. 2020, studentaid.gov/data-center/student/portfolio.

Friedman, Zack. “Student Loan Debt Statistics In 2019: A $1.5 Trillion Crisis.” Forbes, Forbes Magazine, 14 Oct. 2019, www.forbes.com/sites/zackfriedman/2019/02/25/student-loan-debt-statistics-2019.

Geffner, Marcie, et al. “How Long Does Bankruptcy Stay on Your Credit Reports?” Credit Karma, 12 Aug. 2019, www.creditkarma.com/advice/i/bankruptcy-credit-reports/.

Minsky, Adam S. “A Judge Just Wiped Out This Man's $221,000 In Student Debt.” Forbes, Forbes Magazine, 22 Jan. 2020, www.forbes.com/sites/adamminsky/2020/01/22/a-judge-just-wiped-out-this-mans-221000-in-student-debt/.

“Parent PLUS Loans.” Federal Student Aid, 1 Apr. 2020, studentaid.gov/understand-aid/types/loans/plus/parent.

“Unpaid Student Loans: Can They Garnish Your Tax Refund to Collect?” Https://Randolphlawfirm.com, Taylor Randolph Law Firm, 27 Jan. 2017, randolphlawfirm.com/blog/unpaid-student-loans-can-they-garnish-your-tax-refund-to-collect/.

“You May Be Able to Keep Your Home When Filing Bankruptcy.” Https://Randolphlawfirm.com, Taylor Randolph Law Firm, 13 Apr. 2018, randolphlawfirm.com/blog/when-filing-bankruptcy/.