Student Loans May Be Reclassified As Dischargeable in Bankruptcy

July 14, 2011

With the nation's economy struggling, and unemployment still at historic levels, it is no surprise that many former students are struggling with repaying their loans. Last year, the United States Student Association estimated that borrowers held $730 billion in student loan debt, with 60 percent ($440 billion) in deferment or default. With student loan debt outpacing revolving credit card debt, bankruptcy is becoming a consideration for more struggling with crippling student loan debt, even though current law does not allow discharge of such debt, except under limited circumstances.

There is growing speculation that this may change. In April 2010, Senators Richard Durbin (D-IL) and Al Franken (D-MN) introduced the Fairness for Struggling Students Act, while Congressmen Steve Cohen (D-TN) and Danny Davis (D-IL) brought the Private Student Loan Bankruptcy Forgiveness Act to the House of Representatives. While they did not garner much support last year, these acts were recently reintroduced as new job numbers suggest that the economy will not grow as originally expected.

Currently, education loans are considered "non-dischargeable debt." This means that student loan debt cannot be cancelled through bankruptcy absent a showing of "undue hardship," a notoriously difficult legal standard to satisfy. Essentially, debtors must show that they cannot maintain a minimum standard of living while paying the loans, that their poor financial situation is likely to continue, and that they made a good faith effort to repay the loans.

Under the U.S. Bankruptcy Code, "education loans" include federally funded student loans, as well as private loans issued by private banks. Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, private educational loans were treated like any other consumer debt. The proposed legislation would reclassify private educational loans as unsecured consumer debt, which would enable them to be discharged like credit cards, car loans and other types of privately issued debt.

Naturally, private lenders are ambivalent about the proposed changes, believing that they should not be singled out because of debtor's poor financial choices. However, there is growing sentiment that banks should be more judicious in giving student loans, especially considering the profits made through exorbitant penalties and interest. With the possibility of risky loans being discharged in bankruptcy, banks would be forced to make pragmatic decisions about such loans.

If you are considering bankruptcy to eliminate student loan debt, contact an attorney to learn more about your rights and options.

Article provided by Trepeck Bane PC
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