Discharging Student Loans in Bankruptcy Filings May Soon Become Easier

The 2005 Bankruptcy law that that slammed the door on student loan write-offs in a bankruptcy filing may be rolled back if the Obama administration gets its way.

An October 13 Department of Education (ED) report identifies solutions it believes will lead to better outcomes for people struggling with student loans.

The biggest bone thrown to borrowers would be the removal of barriers to writing off private loans in a bankruptcy, found in the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, which was passed after heavy lobbying by private lenders. The Obama administration’s proposal would also extend enhanced borrower protections found in federal loans to private student loans.

ED's report comes on the heels of the Department's July guidance that spells out how bankruptcy discharge requests for Federal student loans should be dealth with. That guidance rolled out amid the Corinthian College student loan debt strike staged by borrowers who wanted write-offs of the loans they took to attend schools now considered part of a fraudulent enterprise.

ED, for its part, seemed to be ready to strike a balance between collecting on their loans and removing unreasonable hardships on the debtor. Under Secretary of Education Ted Mitchell noted that other types of consumer debt — mortgages, credit cards and auto loans — are dischargeable in a bankruptcy, and student loans shouldn’t be an exception.

"We feel strongly that while there are protections built into the (Federal) Direct Loan program that are important for borrowers, there aren't parallel protections for borrowers in the private student loan market," Mitchell said. "We think it's important to do what we can to create those protections, and we think starting with a (new) bankruptcy provision is the way to go.”

While getting a student loan write-off in a bankruptcy filing is notoriously hard, people who meet certain conditions can potentially have good outcomes. A 2012 study by Jason Luliano, a Ph.D. candidate at Princeton University, found that loan charge-offs on the grounds of undue hardship were successful 40% of the time. Nearly all cases examined in the study succeeded if those petitioning the court were unemployed, had a medical hardship or had lower annual incomes the year before they filed for bankruptcy. Most were pro se cases, meaning the petitioners were not represented by an attorney. The report found that people representing themselves were just as likely to win in court as those who lawyered up. Luliano also found that only 0.1% of peoplewho filed for bankruptcy attempted to have their student loans included in any discharge.

ED is also wrestling with what constitutes “undue hardship” which would also affect Federal loans.


For now, an undue hardship claim is the only out for people trying to get their student loans discharged under current bankruptcy law. Earlier this year, the Obama administration indicated that it would broaden the definition to increase the likelihood of discharges.

The July guidance recommended that guaranty agencies, those companies that act as ED’s debt collectors for Federal loans, do more to take borrower’s rights into account when they go into collection mode.

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