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Should Student Loans Be Dischargeable in Bankruptcy

The Below article appeared recently in the Wall Street Journal. When I first became a lawyer, my first job was as the Staff Attorney for the Standing Chapter 13 Trustee in the Trenton and Camden vicinages. At that time student loan debt was dischargeable provided that you had made seven years worth of payments on the student loan you were attempting to discharge. That changed in 1998, when Congress made student loans non-dischareable. I think it has come time for Congress to consider bringing back some ability for debtors to discharge student loans again, as it has increasingly become a major problem for both young adults that are graduating college with crushing amounts of student loan debt and also these students parents that are co-obligors on that debt. This article makes some of these same points:

Should the bankruptcy code be amended to make it easier for borrowers to seek forgiveness of student loan debt through a bankruptcy filing?

The explosive growth of student debt has become not only a mounting political issue, but its near-suffocating effect on millions of Americans also is causing considerable macroeconomic impacts.

The statistics are daunting: Total student debt now exceeds $1.2 trillion, up from only $240 billion just 12 years ago. During this period, the number of borrowers has increased more than 65% to nearly 40 million, with average student loans increasing nearly 50%. And as graduate school ranks increased during the most recent financial downturn, average student debt for these former students is now approaching $100,000.

There are many causes for these dramatic increases. Tuition is increasing at far greater than the rate of inflation, and enrollment at “for-profit” colleges, which are highly dependent on “risky” student loans, is exploding. It’s no wonder that the default rate on student loans is the highest of any debt category, approaching close to 20%.

While a college education unquestionably enhances future earning power, the price of this economic mobility is dramatically affecting ultimate financial independence. Savings rates are at all-time lows, job choices are increasingly based on debt service and 75% of student borrowers have the deferred home purchases due to their debt load.

Although a number of discussions are occurring in Washington and elsewhere to help alleviate the burden of student debt, one option that remains off the table for these millions of borrowers is access to the bankruptcy courts. Of course, prior to 1976, student debt was fully dischargeable in bankruptcy. Relying on ill-founded concerns that a floodgate of bankruptcy filings would deplete federal lending, by 2005, student loans were for all intents and purposes not dischargeable in bankruptcy.

There are a number of reasons why the bankruptcy code should be changed to permit student loans to be discharged. First, the legislative rationale underlying the elimination of dischargeability is no longer persuasive. Second, permitting student-loan borrowers, like borrowers under any other loan, to have access to the bankruptcy courts can serve the long-standing federal policy of allowing debtors the breathing room necessary to restructure their affairs. The policy is no less persuasive with student debt, which has a much more devastating impact on less economically advantaged households—60% of the student debt is held by households with less than $8,500 in net worth. It’s inexcusable to deprive these consumers with the same access to the bankruptcy courts as other consumers.

Adding a minimum repayment period before eligibility for bankruptcy, which existed in previous iterations of the bankruptcy code, would help to prevent acts of fraud. More critically, as with any bankruptcy debtor, those whose collateral (the value of their education) exceeds the amount of their debt will not require wholesale access to the bankruptcy courts. Thus, bankruptcy should only be necessary for those who desperately need it to obtain relief from the unyielding cycle of student debt. This is precisely what the bankruptcy court was crafted to accomplish.

Rick Chesley is the co-chair of DLA Piper’s restructuring practice, focusing on bankruptcy transactions both in the United States and internationally. He is based in Chicago.

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