But the ability to discharge student loans in bankruptcy has been eroded over the years to the point where now the borrower has to prove that any student loan, even a privately issued one, would cause an “undue hardship” to them in order to get it discharged. Whether a debtor can prove this or not may depend completely on which state the debtor lives in, as the Supreme Court has not provided guidance on what the standard means, and courts interpret it in different ways, according to Austin.
Another wrinkle is that in order to discharge a student loan debt, a debtor needs to file a separate action and argue in front of the bankrupty court, a process that usually requires an attorney and money. And according to an April report from the National Consumer Law Center, a legal services nonprofit agency for low-income consumers, most individual debtors, especially those most in need of a hardship discharge, are not able to afford the costs needed to go to court.
“The reason we have bankruptcy laws is that going back to founding of this country, we believe people get a second chance,” said Bergeron, one of the authors of the Center for American Progress report. “Even for federal loans, if you as a student go into programs that don’t adequately prepare you for the work force, that is, if you’re prepared in college but can’t find a job in your field, through no fault of your own, you shouldn’t have the obligation of repaying that loan. That creates some fundamental unfairness that is inconsistent with reasons for the bankruptcy system.”
Reforming the code
Experts have proposed a number of fixes that would help out borrows stuck under unmanageable debt burdens.
Austin has proposed allowing all private loans to be dischargeable, as he believes lenders should not get the “best of both worlds": lending to whomever they want at whatever terms they want while not having to participate in the loan forgiveness programs — in which a borrower repays an affordable amount over 20-25 years before getting the rest discharged — required of government-backed loans. He also proposed allowing bankruptcy courts to value a debtor’s student loan at its fair market value, which is what another investor would be willing to pay to buy the loan off the original lender, and discharge anything above that value. A similar process is currently available to some debtors on their mortgages in bankruptcy.
Bergeron and Valenti propose creating a set of “qualified loans” that meet certain lending standards: reasonable interest rates and fees, deferment and forbearance provisions similar to today’s federal student loans, and access to income-based repayment. Loans that shared these characteristics would be unlikely to substantially harm debtors, and so would remain nondischargeable in bankruptcy. But loans that did not meet these standards, whether public or private, would be dischargeable.
But given the enormity of the student loan problem, even experts who propose bankruptcy reform think other issues must be addressed to control costs and make student loans a good bargain for young borrowers.
“Bankruptcy doesn’t solve the whole problem,” Austin said. “Thirty million households owe student debt. There are different figures on default, but the overall average may be 30 percent [of student loan borrowers] depending on what set of numbers you look at. That’s a lot of people, and we might be better if we have them back in the economic grid.”
Bergeron thinks that it’s going to take a lot more than even the president’s proposal and bankruptcy to fix the system. He proposes looking at institutions, both for profit and nonprofit, who are doing innovative things to get students to graduation and employment. “It’s gonna take more than those two pieces — it takes more than the president’s plan and bankruptcy reform. It really needs to be everyone thinking about driving down costs and improving quality. Because if we don’t do it, somebody else will. And by somebody else I mean some other country will. And they’re going to kill us.”