Should Student Loan Debt Be Easier to Discharge in Bankruptcy? – Top 3 Pros & Cons

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Americans owe more than $1.64 trillion in student loan debt, and the average 2019 graduate owes $29,900. [1] For the nearly eight million borrowers currently in default—meaning they have not made a payment for at least 270 days—declaring bankruptcy and starting over may seem like an appealing option. [3] Credit card debt, medical bills, auto loans, and even gambling debt can be canceled by declaring bankruptcy, but thanks to a 1976 law, discharging student loan debt is much more difficult. [10] [4]

Educational debt was dischargeable before 1976, when Congress altered the bankruptcy code out of concern that people wouldn’t pay back federal student loans. [4] Later, private student loans were also protected from discharge in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. [5] According to the US Department of Education, people who declare Chapter 7 or Chapter 13 bankruptcy can have student loan debt canceled, but only if a court finds there is evidence of “undue hardship.” [6] Getting student loans discharged is notoriously so rare that many lawyers advise clients not to try: less than 0.5% of student loan holders end up clearing their debts in bankruptcy. [7]

Source: Data Science Central, “Student Loans: A Subprime Time-Bomb for the US Government?,” available at datasciencecentral.com, Nov. 18, 2016
Proponents of expanding student loan debt discharge argue that denying students the benefits of bankruptcy is unfair, and that student loan discharge would fix a system that disproportionately hurts minority students as well as encourage entrepreneurship and boost the US economy.

Opponents of making it easier to get rid of school debt during bankruptcy argue that expanding student loan debt discharge would allow borrowers to abuse the loan system, could destroy student loan programs, and would incite colleges to raise tuition.

 

Should Student Loan Debt Be Easier to Discharge in Bankruptcy?

Pro 1

Denying student loan debtors the benefits of bankruptcy is unfair.

The US Supreme Court said in 1915 that the benefits of bankruptcy allow debtors to “start afresh free from the obligations and responsibilities.” [8] Famous business leaders from Henry Ford to President Donald Trump have used bankruptcy for a fresh start. [9]

Car loans, credit card charges, medical bills, and even gambling debts can be discharged in bankruptcy; not allowing educational debt to be discharged is unfair. [10] Mark Huelsman, EdM, Senior Policy Analyst at Demos, wrote, “[I]n a world where most students must borrow for a credential, borrowers should receive the same failsafe protections on these loans as they do on any other consumer loan.” [11]

Students who didn’t understand the consequences of taking out big loans at age 18 or who were misled about future job prospects can be saddled with six-figure debt for decades. [17] [20]

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Pro 2

Student loan discharge would fix a system that disproportionately hurts minority students.

If student loan debt were reduced for households making $50,000 a year or less, the wealth gap between black and white households would decrease by nearly 37%, and by over 50% among those making under $25,000, according to a study by the Institute of Assets & Social Policy at Brandeis University and Demos. [18] While black students graduate with more debt than white students, the disparity only grows and they owe double what their white counterparts owe within four years. [32]

Discrimination in hiring and wages puts black borrowers at an even bigger disadvantage as compared to their white classmates. [33] “Sending African American students into an inequitable adulthood with large debts from college can put them even further behind than they already start,” said Ben Miller, Senior Director for Postsecondary Education at Center for American Progress. [19]

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Pro 3

Student loan discharge would encourage entrepreneurship and boost the economy.

Student loan borrowers delay retirement savings, car purchases, home purchases, starting a business, and even marriage due to their financial burdens. A survey by American Student Assistance found that 35% of respondents “found it difficult to buy daily necessities because of their student loans” and 61% said their student loan debt impacted their ability to start a small business. [24] 55.7% of millennial renters said they could not buy a home because of their student loan debt. [25]

Senator Elizabeth Warren (D-MA) said, “The enormous student debt burden weighing down our economy isn’t the result of laziness or irresponsibility. It’s the result of a government that has consistently put the interests of the wealthy and well-connected over the interests of working families.” [26]

Student loan debtors aren’t just recent college grads; the number of people over the age of 60 who are saddled with educational debt has quadrupled since 2005. [36] People of all ages could become economically productive again if they were able to discharge student loans in bankruptcy and start fresh. [34]

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Con 1

Student loan discharge would allow borrowers to abuse the loan system.

Making it easier to discharge loans would give people an incentive to take out loans with no intention of paying them back, or to borrow more than they need. [12] 30% of college students polled by LendEDU said they used student loan money to pay for spring break trips. [13] Allowing students to discharge educational debt could cause them to seek bankruptcy without fully realizing the negative long-term consequences on their credit scores and other aspects of their lives. [14]

One study found that reinstating bankruptcy protection would increase loan defaults by 18%. [15] A Heritage Foundation study said, “Students who borrow money for college shouldn’t be bailed out–bailouts only encourage additional bad behavior by future students.” [16] New college graduates rarely have significant assets to surrender in bankruptcy, so they have less incentive to avoid bankruptcy. [23]

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Con 2

Allowing easier bankruptcy discharge could destroy student loan programs.

Over 40% of American students with federal student loans aren’t making payments and one in six are in default. [31] In the end, the federal government collects only 80 cents on the dollar for defaulted loans, meaning the US taxpayers lose billions of dollars on those federal loans. [21] Making it easier to discharge debt in bankruptcy would increase the default rate and the money the federal government loses on its student loan programs. “These bankruptcies could easily destroy the federal student loan programs,” argued Allen Ertel, former Congressman (D-FL), noting that federal student loan defaults increased 300% from 1972 to 1976, when Congress enacted strict conditions for discharge. [22]

The availability of private student loans increased after the 2005 law introducing nondischargeability for that type of loan; undoing that law could make private loans more expensive and difficult to obtain. [23]

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Con 3

Student loan discharge would incite colleges to raise tuition.

Student debt elimination through bankruptcy would encourage increased borrowing, and more borrowing leads to higher tuition. The National Bureau for Economic Reform cited expansions in borrowing limits as “the single most important factor” in driving up college tuition, responsible for 40% of the increases. [27]

Abigail Hall Blanco, PhD, Assistant Professor of Economics at the University of Tampa, said, “loan forgiveness would be one giant subsidy, creating perverse incentives for both schools and students. If schools knew the government would forgive the cost of their students’ education, they’d face no incentive to cut costs to keep tuition down.” [28] Tuition at for-profit colleges eligible for federal student aid is 78% higher than at colleges ineligible for such programs. [29]

Jason Delisle, former Director of the Federal Education Budget Project at the New America Foundation, said “You’ve essentially got a tool to make your students price-indifferent.” [30] The Federal Reserve Bank of New York found that “a credit expansion will raise tuition paid by all students.” [35]

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Discussion Questions – Things to Think About

 

  1. Is getting rid of student loan debt by declaring bankruptcy different than being able to cancel credit card or gambling debt? Does one situation seem more or less fair to you and why?
  2. What other pros and cons can you list for being able to get rid of student loan debt by declaring bankruptcy? Which side do you find more compelling?
  3. Should college tuition be reduced or free? What might the impact of lower tuition be on the overall economy?

Footnotes:

  1. Student Loan Hero, “A Look at the Shocking Student Loan Debt Statistics for 2020,” studentloanhero.com, Jan. 15, 2020
  2. Zack Friedman, “Student Loan Debt in 2017: A $1.3 Trillion Crisis,” forbes.com, Feb. 21, 2017
  3. Kim Clark, “A Record Number of People Aren’t Paying Back Their Student Loans,” time.com, Mar. 14, 2017
  4. Ashlee Kieler, “You Can’t Discharge Your Student Loans in Bankruptcy Because of Panicked 1970s Legislation,” consumerist.com, Mar. 17, 2015
  5. John O’Connor, “Make Student Loan Debt Dischargeable in Bankruptcy… Again,” natlbankruptcy.com, Feb. 28, 2014
  6. Federal Student Aid, “Discharge in Bankruptcy,” studentaid.ed.gov (accessed Jan. 4, 2018)
  7. Bill Fay, “Bankruptcy & Student Loans,” debt.org (accessed Jan. 4, 2018)
  8. US Supreme Court, Williams v. United States Fid. & Guar. Co., justia.com, 1915
  9. Ethan Trex, “7 Wildly Successful People Who Survived Bankruptcy,” mentalfloss.com, Nov. 6, 2015
  10. Brett Greene, “The $1 Trillion Student Loan Debt Bubble: An Interview with Robert Applebaum,” huffingtonpost.com, Nov. 11, 2011
  11. Mark Huelsman, “Want to Help Struggling Student Loan Borrowers? Start with Bankruptcy Reform,” demos.org, May 31, 2017
  12. Kelsey Sheehy, “Undergrads Blow It with Student Loan Refunds,” usnews.com, July 24, 2013
  13. Mike Brown, “Spring Break Student Loan Study,” lendedu.com, Mar. 8, 2017
  14. Federal Student Aid, “Understanding Delinquency and Default,” studentaid.ed.gov (accessed Jan. 2, 2018)
  15. Constantine Yannelis, “Strategic Default on Student Loans,” fmaconferences.org, Feb. 2017
  16. Lindsey Burke and Andrew Kloster, “Why the Government Shouldn’t Subsidize Student Loans,” dailysignal.com, Dec. 18, 2015
  17. Jeffrey J. Selingo, “Did Your College Mislead You About Job Prospects? It Might Become Far Easier to Have Your Loans Forgiven.,” washingtonpost.com, July 20, 2016
  18. Danielle Douglas-Gabriel, “Student Debt Forgiveness Could Narrow the Racial Wealth Gap,” washingtonpost.com, Nov. 25, 2015
  19. Ben Miller, “New Federal Data Show a Student Loan Crisis for African American Borrowers,” americanprogress.org, Oct. 16, 2017
  20. Megan Thompson, “Are You Older Than 60 and Paying off Student Loans? Tell Us Your Story.,” pbs.org, Sep. 3, 2017
  21. Jason Delisle, “CBO Issues Fresh Evidence That Student Defaults Cost Taxpayers,” newamerica.org, July 30, 2012
  22. Chuck Stewart, Bankrupt Your Student Loans and Other Discharge Strategies: You Can Do It!, 2006
  23. Rajeev Darolia, “Should Student Loans Be Dischargeable in Bankruptcy?,” brookings.edu, Sep. 29, 2015
  24. American Student Assistance, “LIFE DELAYED: The Impact of Student Debt on the Daily Lives of Young Americans,” asa.org, 2015
  25. Terri Williams, “10 Ways Student Debt Can Destroy Your Life,” investopedia.com, Oct. 5, 2015
  26. Elizabeth Warren, “I’m Calling for Something Truly Transformational: Universal Free Public College and Cancellation of Student Loan Debt,” medium.com, Apr. 22, 2019
  27. Grey Gordon and Aaron Hedlund, “Accounting for the Rise in College Tuition,” nber.org, Feb. 2016
  28. Abigail Hall Blanco, “Don’t Forgive Us Our Debts: The Case against Student Loan Forgiveness,” insidesources.com, Apr. 14, 2015
  29. Stephanie Riegg Cellini and Claudia Goldin, “Does Federal Student Aid Raise Tuition? New Evidence on For-Profit Colleges,” harvard.edu, Nov. 2014
  30. Sophie Quinton, “The Problem with Student-Loan Forgiveness,” atlantic.com, Apr. 21, 2014
  31. Josh Mitchell, “More Than 40% of Student Borrowers Aren’t Making Payments,” wsj.com, Apr. 7, 2016
  32. Emily DeRuy, “The Racial Disparity of the Student-Loan Crisis,” theatlantic.com, Oct. 24, 2016
  33. Marshall Steinbaum and Kavya Vaghul, “How the Student Debt Crisis Affects African Americans and Latinos,” equitablegrowth.org, Feb. 17, 2016
  34. Preston Mueller, “The Non-Dischargeability of Private Student Loans: A Looming Financial Crisis?,” law.emory.edu, 2015
  35. David O. Lucca, Taylor Nadauld, and Karen Shen, “Credit Supply and the Rise in College Tuition: Evidence from the Expansion in Federal Student Aid Programs,” newyorkfed.org, Feb. 2017
  36. Consumer Financial Protection Bureau, “Snapshot of Older Consumers and Student Loan Debt,” consumerfinance.gov, Jan. 2017