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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Jan 11, 2013

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Student loans are the one form of debt that is near impossible to absolve, or so it seems.

But what if reality is more hopeful?

In Jason Iuliano’s study, “An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard,” he finds that almost all student loan debtors who file for bankruptcy do not attempt to discharge their student loans.

Iuliano, a Harvard Law School graduate and a current Ph.D. candidate at Princeton University, illuminates another side of the highly covered student loan debate.

Iuliano said the biggest failure of the student loan discharge process is a failure by in-need loan participants.

“Incredibly, only 0.1 percent of student loan debtors who have filed for bankruptcy attempt to discharge their student loans,” Iuliano said in the report. “99.9 percent of bankrupt student loan debtors do not even try to discharge their student loans.”

According to the report, successful debtors differ from those unable to absolve their debt in three different respects.

  1. They are less likely to be employed.
  2. They are more likely to have a medical hardship.
  3. They are more likely to have lower annual incomes the year before they filed for bankruptcy.

How Student Loans Differ

A common way out of unmanageable consumer debt is through bankruptcy.

But normal bankruptcy does not discharge student loan debt. Congress requires that debtors file an adversary proceeding. This forces debtors to prove during court proceedings that they are suffering an “undue hardship.”

The act which defines this rule, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, failed to define what “undue hardship” is, so the task usually falls under each court’s jurisdiction.

Currently, the Brunner standard has come to dominate the field, which requires debtors to establish three elements:

  1. “That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for herself and her dependents if forced to repay the loans;
  2. That additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
  3. That the debtor has made good faith efforts to repay the loans.”

Although some private student loans can be discharged outside of the bankruptcy process; this rule does not apply to federal loans. Bankruptcy is the only way to absolve federal student loans.

Less than 15 percent of borrowers have private student loans. Since federal loans are the most common type of student loans, non-court private loan discharge represents a small percentage of the whole.

Gary Armstrong, shareholder of the Armstrong Kellett Bartholow P.C. law firm, primarily deals with bankruptcy cases but does not believe that federal loans are the only loans that consumers should worry about.

Although they make up the minority, Armstrong believes that private loans will begin to impact the overall student lending crisis on a bigger scale.

“People haven’t realized the private student loan side of it,” he said. “Lenders are doing what they have to do to collect them. I think it is going to be a debacle.”

The Study Findings

According to Iuliano’s study, in 2007, out of the total 822,590 consumer bankruptcy filings, there were 169,774 debtors who owed student loans to at least one of the ten major lenders. Out of the total, only a measly 217 filed an adversary proceeding in order to discharge their student loan debt.

Out of the 217 debtors who filed, half received some type of debt relief. Twenty-five percent of the total 217 participant sample received full discharges, 14 percent received partial discharges, and 12 percent were put on administrative repayment plans.

For the few debtors who received help, Iuliano found that a much larger number could have received loan discharges if they filed for an adversary proceeding.

The study calculated non-discharge seekers who met the original respects (less employment, medical hardship, low annual income) and found that 7.2 percent of non-discharge seekers met all three of the requirements. About 21.9 percent met two of the elements.

In 2007, out of the 238,446 student loan debtors: 17,000 (7.2 percent) who met all three measures and 52,000 (21.9 percent) who met two of the three measures. In total, a staggering 69,000 people would have had a good chance to discharge their student debt. In reality, less than 300 even attempted the feat.

“A debtor cannot obtain a discharge if he never asks for one, and 99.9 percent of student loan debtors in bankruptcy fail to ask for one,” Iuliano said.

But everyone is not convinced.

Armstrong does not believe this number should be as high. He said that in reality, the bankruptcy cases are more complicated than the study suggest.

Armstrong said the “undue hardship” rule is what makes loan discharges complicated. He said it is a “difficult standard to meet for anybody.”

He said that the study is misleading because it fails to mention the steps that debtors can make to reduce the need to file bankruptcy. If debtors are able to clear up their credit card debts, they would be able to repay their student loans.

Additionally, some student’s debt balance is a manageable number. Armstrong said that because of this, a large number of those 99.9 percent wouldn’t be eligible for the discharge.

Justice without Legal Counsel

According to the study, one possible reason why debtors fail to absolve their student loans deals with legal counsel. Many bankruptcy applicants are fearful of the legal process and believe that the process requires more knowledge or money than they can provide.

But Iuliano’s study suggests that a lack of legal counsel does not impact the case outcome. It found that debtors can be successful without an attorney.

“There was no statistical difference in outcome between pro se debtors and debtors represented by an attorney,” he wrote. “Debtors without attorneys were just as likely to receive hardship discharges of their student loan debt as were those debtors who had counsel.”

In addition, the cost of pursuing a student loan discharge is relatively low compared to the cost of filing bankruptcy.

But Armstrong disagrees.

Armstrong said the legal fees can vary from $5,000 to $10,000 and up for a bankruptcy case, further burdening those who are past-due on their financial obligations.

“Bankruptcy lawyers don’t want to undertake what could be expensive litigation in bankruptcy court for a debtor who cannot pay the legal fees,” he said.

In the end, those seeking assistance simply cannot pay for additional legal fees.

“The system doesn’t make it easy for those who are able, who are eligible,” he said. “The system doesn’t make it easy for those folks to do that.”

And for those who choose to go pro se, without an attorney, the information simply isn’t there.

Armstrong said it will be a “huge uphill battle for them.”

“I think it is dangerous to suggest that people should try to file these cases themselves. I think it is a big problem that people can’t afford to have a lawyer do it for them,” he said.

Armstrong said some judges might be open to pro se debtors, but it depends on the judge’s personality and opinion of the law.

Regardless of price, a final factor to consider is fear.

“Quite reasonably, they do not think they will be able to represent themselves against a large company such as Sallie Mae or Wells Fargo,” Iuliano said.

Self-Fulfilling Prophecy

Maybe the biggest problem is not the court proceedings, but rather the coverage of debt absolution in its entirety.

Iuliano writes that the perception that student loan discharges are impossible to obtain “may be a self-fulfilling prophecy.”

The study found that 39 percent of debtors who filed an adversary proceeding receive full or partial debt discharge.

But Armstrong said that to say that nearly 40 percent of debtors could discharge their debt is not a fair reading of the statistics.

What is fair to Armstrong then, is that “there is a small minority of those who have a really good chance to get it discharged, but never really try.”

Part of the issue could be simply due to a lack of factual information.

“For years, the message in both popular media and academic journals has been that it is extremely difficult to meet the undue hardship threshold,” Iuliano said. “Such bleak reports have produced a chilling effect that deters debtors from pursuing student loan discharges.”

Both Iuliano and Armstrong agree that it is a lack of information which leads to the low number of student loan bankruptcy applicants.

“Instead of criticizing the undue hardship requirement, scholars, policymakers, and consumer advocates could help many more people by informing them both that courts grant a large percentage of student loan discharge requests and that many debtors are successful without the help of a lawyer,” Iuliano said.

Regardless of statistics, the truth is that help is available, yet never accessed.

“Courts are willing to grant discharges. The problem is that few people are asking for them,” Iuliano said.