Why Can’t You File Bankruptcy on Student Loans

Discharging student loans through bankruptcy is considerably harder than it is for other types of unsecured debt, such as medical bills or credit card balances. The key obstacle in a bankruptcy case is the need for borrowers to demonstrate ‘undue hardship,’ a stringent legal standard that varies across jurisdictions and is often challenging to meet.

The policy that treats student loans differently arose from fears over potential abuses of the bankruptcy system, particularly impacting federal student loan programs. There was speculation that students might exploit the system by borrowing substantial amounts from lenders for education and then discharging these loans quickly through bankruptcy after graduation. To curb this potential abuse, Congress began revising bankruptcy laws in the early 1970s, demanding the demonstration of undue hardship for borrowers seeking to discharge student loan debt.

Future changes to these laws have made discharging student loans increasingly challenging, with the undue hardship standard posing a significant barrier. Therefore, for many borrowers, bankruptcy offers little relief from the burden of student loan debt.

Ahead, we’ll explain why student loans aren’t bankruptable, current student loan bankruptcy law, and changes that have happened over time.

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Student loans first became nondischargeable in bankruptcy in 1976 due to an amendment in the Higher Education Act. Section 439A of this act made student loan debt non-dischargeable until five years after the start of the repayment period, except in cases of undue hardship. Over time, laws were tweaked and widened to reinforce this limitation.

Allen Ertel, a Congressman from Pennsylvania, pushed to make student loans hard to discharge. Ertel was in the U.S. House of Representatives from 1977 to 1983. Despite stats showing less than 1% of federal student loans were ever wiped clean in bankruptcy, Ertel argued student loan defaults were jumping up. His convincing talk changed the rules, making student loans stick around after bankruptcy unless the borrower faced severe hardship.

For a more detailed overview of this history, see the video below:

The main reason student loans aren’t wiped out in bankruptcy is the worry about system abuse. The thought was students could rack up loans for school and then declare bankruptcy before getting a job and earning money.

Even though there wasn’t strong proof to back up these worries, they sparked changes in the law that made it harder to erase student loans in bankruptcy.

Today, you can only get rid of student loans in bankruptcy if you’re in a tight spot of hardship.

Related: How to Prove Undue Hardship for Student Loans

Joe Biden has affected the dynamics of student loan debt and its dischargeability, playing two distinct roles:

As a senator, Biden backed multiple pieces of legislation that unintentionally exacerbated the student loan crisis. These laws facilitated the growth of student loan borrowing, often increasing borrowers’ monthly payments and making these loans tougher to discharge in bankruptcy.

As President, Biden’s policy changes have further altered the landscape of student loan dischargeability, albeit in a different direction. While his administration has sought to alleviate the student loan crisis and lighten the burden on borrowers, the reforms implemented may have indirectly made it more difficult for some student loan borrowers to discharge federal loans in bankruptcy.

Here’s how:

1. The administration created the most affordable repayment plan to date, shielding even more of a borrower’s discretionary income from student loan payments. While this new student loan repayment plan provides immediate relief, it might inadvertently discourage some borrowers from seeking bankruptcy discharges.

2. Biden implemented an interest waiver, effectively reducing the debt burden. While beneficial for most, it could indirectly create an environment where discharging student loans through bankruptcy becomes harder.

3. All federal student loan borrowers, including those with a consolidation loan, are eligible to get retroactive credit toward income-based repayment forgiveness. This move alone has already erased $39 billion in federal student loans. Experts expect that this will ultimately lead to a $400+ billion bailout by the federal government, again potentially reducing the instances of borrowers resorting to bankruptcy.

Even though these measures have resulted in erasing over $116 billion in federal student loans through various student loan forgiveness programs and have greatly assisted many borrowers, their secondary effect could be a reduction in bankruptcy filings for student loan discharges.

Department of Justice’s Guidance on Bankruptcy for Student Loans

The Biden administration took a significant step toward easing student loan bankruptcy in November 2022.

The Department of Justice, collaborating with the U.S. Department of Education, issued new guidance designed to simplify the identification of cases warranting student loan bankruptcy.

This key initiative underscores the administration’s commitment to providing struggling student loan borrowers with a clearer path to bankruptcy.

Before 1976, student loans were treated like most other forms of debt, allowing for discharge through bankruptcy proceedings.

But the landscape was upended with the introduction of the ‘undue hardship’ clause in 1976 via Section 439A of the Higher Education Act.

This clause mandated a five-year waiting period from the start of the repayment period before discharging student loan debt, except in cases of undue hardship.

Section 439A of the Higher Education Act posited that educational debt should be immune to bankruptcy discharge. Interestingly, evidence at the time suggested less than 1% of federal student loans had ever been discharged in bankruptcy.

Even still, the following years saw a series of notable shifts in student loan bankruptcy law:

• 1978: The Bankruptcy Reform Act repositioned the exception to bankruptcy discharge of student loans from the Higher Education Act to the U.S. Bankruptcy Code at 11 USC 523(a)(8).

• 1979: An Act on August 14th closed a loophole in the Perkins loan program and extended the 5-year restriction if the student loan borrower sought deferment or forbearance.

• 1984: The 1984 Amendment removed the phrase “of higher education” from “nonprofit institution.” This change was made to include federal loans made by nonprofit institution centers that weren’t focused on higher education: seminaries, barbering colleges, etc.

• 1990: The Crime Control Act made conditional grants of money for education nondischargeable. Before this change, it was arguable that an ROTC scholarship recipient who didn’t fulfill his obligation could file bankruptcy and not have to pay his scholarship back. Following this change, a former ROTC cadet would have to prove undue hardship or wait until the repayment period lapsed before he could discharge his student loans. It also increased the waiting period to get a discharge of student loans from 5 years to 7 years.

• 1998: The Higher Education Amendments Act ruled federally guaranteed student loans non-dischargeable unless the borrower could establish undue hardship.

• 2005: The Bankruptcy Abuse Prevention and Consumer Protection Act extended non-dischargeability to private student loans.

Related: Are Student Loans Consumer Debt?

Here’s a slide deck showing the history of these amendments.

The integration of the undue hardship clause and later law amendments have significantly shaped the bankruptcy terrain for student loans, creating a formidable burden of proof for borrowers wishing to establish undue hardship.

The ‘Undue Hardship’ Test

Most courts now require debtors to satisfy three conditions:

1. The debtor cannot maintain a minimal standard of living for herself and her dependents if forced to repay the loans.

2. Additional circumstances exist indicating that the debtor’s financial situation is likely to persist for much of the student loan repayment period.

3. The debtor has made a good-faith effort to repay the loans.

Over time, two primary tests, the Brunner Test and the Totality of Circumstances Test, have emerged to assess whether a debtor fulfills this undue hardship standard.”

Current Student Loan Bankruptcy Law

In the current state of student loan bankruptcy law, according to Section 523(a)(8) of the U.S. Bankruptcy Code, student loans are exempt from discharge, barring instances of undue hardship.

Specifically, 11 USC § 523(a)(8) states that education debt, including federal loans and private loans, cannot be discharged in both Chapter 7 bankruptcy and Chapter 13 bankruptcy (type of bankruptcy) in some cases.

Related: What Happens to Student Loans in Chapter 13?

These conditions cover various scenarios, such as the loan being made, guaranteed, or insured by the government, made under a government-funded loan program, or meeting the IRS’s criteria to be a qualified education loan.

But discharging student loans in bankruptcy is highly restricted and tougher than most other types of unsecured debt, like medical bills, credit card debts, or personal loans.

You must not only file a Chapter 7 or Chapter 13 bankruptcy, but you also must file a separate lawsuit known as an adversary proceeding. That’s where you use the Education Department or private lender and ask the bankruptcy judge to discharge or forgive the remaining loan balance.

Related: How to File an Adversary Proceeding to Discharge Student Loans

There have been considerable legislative proposals and administrative actions in recent years aiming to alleviate student loan debt.

The U.S. Department of Justice and the U.S. Department of Education issued guidance in November 2022 to identify appropriate cases for bankruptcy discharge of student loans.

This move urged Department of Justice attorneys to:

• Affirm facts showing undue hardship.

• Recommend the discharge of a debtor’s student loan in some cases.

Introduction of Attestation Form

The authorities introduced a new Attestation Form and a simplified ten-step process to aid bankruptcy debtors in securing discharges for their student loans.

The overarching goals of these steps include creating “clear, transparent, and consistent expectations” for discharge, simplifying the process for debtors, and increasing instances where the Department of Education supports a discharge.

Policy Proposals and Legislative Changes

Several policy proposals, such as the FRESH START Through Bankruptcy Act and the Private Student Loan Bankruptcy Fairness Act, have been put forward. They aim to reform the handling of federal and private student loans in bankruptcy proceedings. Specifically:

• The FRESH START Through Bankruptcy Act intends to make federal student loan debt dischargeable in bankruptcy ten years after the loan enters repayment.

• The Private Student Loan Bankruptcy Fairness Act proposes to revert the treatment of private student debt to its pre-2005 status, rendering it dischargeable in bankruptcy.

Related: Student Loan Cosigner & Bankruptcy: How it Works

Despite these developments, the undue hardship standard continues to pose significant hurdles for borrowers. Repayment options such as deferment, forbearance, income-driven repayment plans, and loan cancellation opportunities do not directly influence the bankruptcy process or the challenge of discharging student loans in bankruptcy.

Reforms by the Biden Administration

The Biden administration has implemented several reforms to decrease the burden on borrowers and enhance the student loan system. These include:

• Modifying income-driven repayment plans.

• Automating loan forgiveness for eligible borrowers.

• Introducing the IDR Waiver.

But these measures, while beneficial, do not directly impact the bankruptcy process or the dischargeability of student loans in bankruptcy.

While efforts have been made to ease the process of discharging student loans in bankruptcy, there remain several arguments against such changes. Here are three key points raised by opponents:

1. Moral Hazard

Opponents often cite the potential for moral hazard as a reason against making student loans easily dischargeable. They argue that such a change could lead to:

• Students borrowing recklessly during college, only to file for bankruptcy upon graduation.

• Possible misuse of the bankruptcy system.

• Threats to the stability of educational credit and overall student loan programs.

But as Americans face increasing financial burdens to fund their education, this argument is often countered. The need to borrow large sums to afford education, combined with limited access to debt relief, undermines the validity of the moral hazard theory.

2. Fiscal Integrity of Lending Programs

As the primary creditor for a substantial portion of student loans, the federal government has a vested interest in maintaining the fiscal health of its lending programs. The argument here is that:

• Allowing student loans to be readily discharged could lead to a higher default rate.

• A higher default rate could threaten the sustainability of the student loan program.

• This could potentially reduce the pool of funds available for future borrowers.

3. Availability of Alternative Repayment Options

Opponents point to the various repayment options and forgiveness programs already available to borrowers struggling with student loan debt. They note these alternatives that offer relief without the need for bankruptcy:

• Income-driven repayment plans.

• Deferment and forbearance options.

• The Public Service Loan Forgiveness program.

Bankruptcy, they argue, can have enduring negative effects on an individual’s credit score and overall financial stability, making these alternative options preferable.

The Biden administration’s decision to reinstate student loan payments after a three-year hiatus is likely to impact tens of millions of Americans. Many, unable to balance student loan payments with other living expenses, may find themselves heading to bankruptcy court. This issue could be made even worse by the rising variable interest rates, now creeping into the high teens. Unfortunately, those with late payments on their credit reports may face additional hurdles in refinancing their debts.

In such a scenario, questions around the non-dischargeability of student loans in bankruptcy are bound to arise.

If you find yourself in this predicament, consider consulting a student loan bankruptcy attorney near you to explore your options.

My team and I have assisted borrowers across the nation, from California to New York, in navigating the bankruptcy process to manage their student debt.

Whether it’s understanding your rights or seeking professional guidance, remember that you don’t have to face these challenges alone.