The Truth about Student Debt

There are a few ready talking points when discussing the student-loan crisis: the collective $1 trillion burden of debt, how student debt is now larger than credit card debt in this country, the fact that the 90-day delinquency rate spiked to 11 percent last year, meaning over one in ten borrowers are behind on their payments—all facts that don’t give much hope to those with loans, or those trying to resolve the financial crisis.

Another widely repeated belief is that student loans are completely nondischargeable in bankruptcy, a statement that a quick fact-check proves to be rated “pants on fire” and one that is causing tens of thousands of borrowers to suffer for no reason, for years.

A new empirical study of a nationwide sample of bankruptcy cases by Jason Iuliano, a Harvard Law School graduate and Princeton political science PhD student, shows that in 40 percent of cases where a student loan debtor sought forgiveness of their loans as part of a bankruptcy case, the judge granted at least some relief.  But here’s the kicker: In 2007, the year Iuliano studied, only 0.1 percent of all student debtors who filed for bankruptcy asked the judge to consider writing off all or part of their student loans. “Ultimately, it seems that bankruptcy filers’ lack of accurate knowledge of the system is the main problem,” wrote Iuliano.

Why did self-proclaimed borrowers’ advocates like me perpetrate such an inaccuracy? Well, in normal bankruptcy proceedings, student loans are nondischargeable. In the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, Congress stated student-loan borrowers would be required to file an “adversary proceeding”—a type of lawsuit within a bankruptcy case—to prove “undue hardship” in order to get their loans forgiven.

People who fall behind on their student loans are often hit with punitively high interest rates and penalties that can equal several times the original amount borrowed. The federal government has unusual power to recover its money, for example, by seizing tax returns or disaster relief payments.

Without bankruptcy as a recourse, some desperate student loan borrowers with insurmountable debts are forced to go underground, living without credit of any kind.

Congress did not define undue hardship, so nobody really knew what it meant or how hard a standard it was to meet. But over the past decade the courts have set a widely accepted standard. “Undue hardship” requires people to prove 1) The debtor cannot maintain a minimal standard of living for herself and her dependents if forced to repay;

(2) that there are good reasons to believe this situation will continue for a good part of the repayment period (i.e. this is not a case of a medical student in residency who is going to be earning a $180,000 salary within two years) and (3) that the debtor has made good faith efforts to repay the loans so far.

Iuliano found that judges applied this test in a reasonable way. The 40 percent of people who managed to have some or part of their loans forgiven were less likely to be employed, more likely to have a medical hardship, and had lower annual incomes the year before they filed for bankruptcy, than the sixty percent who failed.

In other words, they were like this anonymous poster on a site featuring personal testimony from many student loan borrowers went up as part of the Occupy protests in the fall of 2011.

“I have an ER bill I can’t pay, an untreated skin condition I can’t see anyone about, wisdom teeth coming in sideways I can’t get corrected, and asthma I treat with coffee to save the inhaler for emergencies,” wrote a young computer programmer with $60,000 in student loan debt. “I live on unemployment in two spare bedrooms in my mother’s double-wide.

I’ve gone bankrupt to escape credit cards, but student loans are for life.” 

Anonymous, if you are reading this, that’s not true. You may be able to catch a break after all. Iuliano’s paper deserves to be much more widely reported—the only mainstream news outlet to pick up the story is the Huffington Post.  The Consumer Financial Protection Agency, which has taken steps to advocate for student debtors, should publish a guide to pursuing student loan discharge with an adversary proceeding. It costs much less than filing for bankruptcy, and you don’t even need a lawyer—Iuliano found no statistically significant difference in outcomes between debtors with and without attorneys.

A leap in student-loan forgiveness rates would offer rescue to the most vulnerable borrowers and help the administration in the eyes of those who support the Occupy movement. It would also, less obviously, be a good thing for the student-loan finance system as a whole. Bankruptcy laws help rationalize the market for credit. Knowing that borrowers have protection will ensure that lenders take seriously the risks that they are assuming, which could help stem the tide of growing loans.

Comments

The fact that few people request full or partial loan forgiveness does not of itself mean that if more people asked for it, more would get it. It may simply mean that the requests are made only in the most deserving of cases and still fail 60% of the time. Also, given the availability of hardship deferrals and programs for forgiveness of debt in the event of long-term disability, some people who might otherwise file for bankruptcy and some who might qualify for full or partial hardship discharges are able to obtain relief through those programs and mechanisms. Also, from what I have seen even in the most extreme cases, hardship discharges of student loans in bankruptcy tend to be partial.

If you want to change the system, and believe that dischargeability in bankruptcy will help correct some distortions in the present market, I agree there's a case to be made -- but I think that's a political argument, to be made to your Member of Congress, as opposed to a valid basis to believe that there are significant numbers of bankruptcy petitioners who are missing out on the opportunity to discharge part of their student loan debt.

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