You Can’t Discharge Your Student Loans In Bankruptcy Because Of Panicked 1970s Legislation

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Although bankruptcy should only be viewed as the last option for consumers drowning in a sea of debt, even this final-straw course of action won’t help Americans with getting out from under hefty student loans — but it wasn’t always this way.

Students being crushed under the weight of mounting student loan debt have few options when it comes to receiving forgiveness for their debts, and bankruptcy is often the least obtainable.

Other debts, including your mortgage and auto loans, are dischargeable through bankruptcy filings, but student loans can only be discharged if the borrower proves “undue hardship” through a court determination.

And that process is surprisingly arbitrary, according to the National Consumer Law Center.

It is entirely up to the court to decide whether a borrower meets the standard, and the standard can vary a great deal, because the bankruptcy code does not provide an actual definition of undue hardship.

But for the sake of an example, the NCLC provides this scenario in which a court might decide that student loan discharge is necessary:

However, even under this circumstance, discharge isn’t a foregone conclusion.

While the process to discharge student loan debt in bankruptcy is long and tedious it wasn’t always that way.

Prior to 1976, student loans weren’t protected from bankruptcy proceedings. But that year, amid concern over high default rates, Congress passed legislation intended to safeguard federal investments.

The first version of the law put a ban on bankruptcy discharges for the first five years after a federal student loan was originated. It did include an undue hardship allowance that could discharge the debt earlier.

Two years later, lawmakers proposed a bill that would have returned bankruptcy rights to student loan borrowers. However, that legislation failed, and discharging federal loans through bankruptcy continued to be prohibited during the first five years after loan origination.

The law changed again in 1990, when the five-year rule was extended to seven years. In 1998, the law was revised again to remove any timeframe for allowable discharges, leaving undue hardship as the only way out.

At the time, this only applied to federal student loans. That changed in 2005, when lawmakers included private student loand debt in a comprehensive bankruptcy amendment [PDF].

Consumer advocates, like those at the NCLC, claim there was little need to pass legislation granting this non-dischargeable status to student loans.

They point to a 1977 study [PDF] from the General Accounting Office which found that only 1% of all matured student loans had been discharged in bankruptcy prior to any protections being put in place.

And according to a 2013 report titled “No Way Out: Student Loans, Financial Distress, and the Need for Policy Reform” [PDF], the current relationship between student loans and bankruptcy was a result of panic and exaggerated stories claiming wealthy doctors would file bankruptcy to discharge student loans.

“In many ways, the action taken in the 1970’s was an overreaction based on fears that negative reports about defaulter might undermine the fledgling student loan programs,” claims the report. “Yet, the exception remains and was even expanded, inexplicably, to private student loans in 2005.”

In the decade since Congress removed the possibility for bankruptcy discharges for almost all student loan borrowers, advocates and some legislators have pushed to give this last-chance option back to borrowers.

The most recent attempt occurred last week when a group of 12 senators introduced legislation that would amend the current bankruptcy code, allowing private student loans to be held in the same regard as other private unsecured debt.

The legislation came just days after President Obama announced the “Student Aid Bill Of Rights” and directed the Department of Education to explore whether or not federal student loans should once again be dischargeable through bankruptcy.

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