Are Narrow Bankruptcy Laws to Blame for Unmanageable Student Debt?

It is no secret that student loan debt has become a serious problem in Illinois and throughout the country. For example, a report in Forbes reported on the “student loan default crisis” earlier this year, citing the total of student loan debt at approximately $1.4 trillion. The article described student loans as “a problem of out-of-control ballooning debt” that may soon lead to a default crisis. Are current bankruptcy laws to blame for a potential student loan default crisis in which thousands of borrowers simply stop making payments due to financial circumstances, leading to a larger economic crisis?
According to a recent article in The Cap Times, some consumer advocates believe that shifts in U.S. bankruptcy laws have narrowed options for student loan borrowers in need of bankruptcy protection.
Historical Changes to U.S. Bankruptcy Law
The article suggests that a “series of incremental changes to federal bankruptcy laws” are to blame for making it “nearly impossible for those with student debt to get bankruptcy protection.” To better understand how bankruptcy laws have changed over the last four decades—and, in many cases, narrowed the options for bankruptcy discharges for consumers—we will provide you with a brief overview of how bankruptcy laws have evolved with regard to student loan debt:
  • 1978: the Bankruptcy Reform Act makes it impossible for student loan borrowers who have federally backed student loans to seek a bankruptcy discharge of student loan debt unless they can prove an “undue hardship.” For many student loan borrowers who have considered seeking bankruptcy protection, this language of “undue hardship” is quite common. Indeed, the Brunner test—one of the most frequently used tests to determine whether student debt is dischargeable in a consumer bankruptcy case—requires that the debtor show that continuing to pay the loans would create an undue hardship. This language originated in the late 1970s with the Bankruptcy Reform Act. The Act also clarified that debtors could not seek a bankruptcy discharge of student loan debt until they were at least five years past graduation.
  • 1990: the waiting period for filing for bankruptcy and discharging student loans increased from five years to seven years after graduation.
  • 1996: the Debt Collection Improvement Act made it lawful for Social Security benefits to be garnished for unpaid student loan debt.
  • 2005: the Bankruptcy Reform Act clarified that any debtor seeking to discharge student loans—whether federally backed loans or private loans—would need to show an undue hardship in order to be eligible for discharge.
Concerns About Bankruptcy Abuse and Student Loan Discharges
According to Megan McDermott, a bankruptcy law lecturer at the University of Wisconsin Law School, the reasons Congress gave over the years for narrowing bankruptcy protections for debtors with student loans largely concerned bankruptcy abuse. In other words, the laws were narrowed to prevent bankruptcy abuse. However, as McDermott argues, “it’s not always clear that there’s evidence behind those fears.”
Although federal loans have become more widely available, and student loans in general are easier to obtain than other types of loans or lines of credit, there is not clear evidence to suggest that student loan borrowers who later file for bankruptcy would be abusing the system. McDermott and others suggest that, if more debtors are not able to discharge student loan debt through bankruptcy, we could see rippling economic effects.
Contact a Bankruptcy Lawyer in Oak Park
Do you have questions about bankruptcy and student loans? An Oak Park bankruptcy attorney can answer your questions. Contact the Emerson Law Firm today.
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