Government

A Senator Proposes To Allow Student Loans To Be Dischargeable In Bankruptcy -- But Is That A Good Idea?

Is this the right way to solve the student loan crisis? Should student loans be discharged with no strings attached?

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As the total national student loan debt of $1.5 trillion continues to grow, so does the number of voters who have to repay them. Many are struggling to do so or have given up altogether. So it appears inevitable that there will be student loan reform.

The current bankruptcy laws make it very difficult to discharge student loan debt. First, the debtor must file an adversary proceeding in bankruptcy court to show that they will suffer an undue hardship if forced to pay the student loans in full. An adversary proceeding is very similar to a civil lawsuit. There is filing of court documents, motions, discovery, and possibly a trial. This means that attorneys fees will be substantially higher than your garden variety Chapter 7 case. And finding a bankruptcy attorney might be harder because some don’t do adversary proceedings at all. Second, the courts have set a very high standard to show undue hardship thanks to the infamous Brunner Test.

Last month, Senator Dick Durbin introduced the Student Borrower Bankruptcy Relief Act. The text of the bill is short and simple: it eliminates the requirement to show undue hardship to discharge student loans in bankruptcy. So no adversary proceeding will be required.  Student loan debt is likely to be treated similar to medical debt.

But is this the right way to solve the student loan crisis? Should student loans be discharged with no strings attached? This is a very complex, divisive, and passionate issue with the number of people on each side growing as time passes.

Supporters of discharge argue that it frees up disposable income for a lot of people which will increase spending and boost the economy. Also, the threat of bankruptcy might force creditors to be more flexible with payment or settlement options.

But opponents say that it creates a moral hazard. To put it simply, you borrowed the money so you should do whatever it takes to pay it back like a responsible, dignified human being. Otherwise, those who sacrificed to pay off their loans look like suckers. And there is usually no collateral for creditors to attach to minimize loss. Also, this makes the current federal student loan program look like a joke. The taxpayers will end up being the guarantors for those who default. And those who can afford to pay it back will refinance with a private bank at a lower interest rate.

This issue is complex because every individual’s circumstances are different and many factors must be considered to determine whether it would be fair to discharge their student loans. Here are a few that I can think of:

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  • What difficulties have they faced in the past and continue to face?
  • What were they studying in school and what were their career goals?
  • What have they accomplished to date?
  • How long have they been in repayment status?
  • Did they work in underserved areas for lower pay?
  • Have they made a good faith effort to repay the loan?
  • What will they do if their loans are discharged (or not)?

Most would think that it would be fair to discharge the loans of someone who made less money due to working in a poor, underserved area for many years. Or for someone who suffered a permanent disability. On the other hand, those who spent their student loan money on vacations, luxury items, or cryptocurrency gambling should be forced to pay them back. Same with people who are mooching in their parents’ basement. And then there are those who think student loans should be dischargeable (or not) no matter what.

One thing is certain. Filing bankruptcy is not a decision people make lightly. The filing goes on your credit report so you will be unable to obtain a loan or mortgage for a number of years after filing. Employers doing background checks will see the bankruptcy and that can negatively affect a candidate’s chances of getting a job. A bankruptcy can put a debtor’s professional license in jeopardy because it is a strong indicator of financial irresponsibility. So this is a decision made as a last resort.

If Congress is serious about reforming student loan bankruptcy law, allowing full discharges with no strings attached goes too far and will be opposed by a significant portion of the population. Instead, there should be some objective criteria that must be met before student loans can be dischargeable in bankruptcy. The criteria should be fair and incentivize people to use bankruptcy only as a last resort and not as a disguised planning tool to escape debt.

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Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at sachimalbe@excite.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.

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