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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Sep 5, 2013

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Many student loan borrowers, overburdened by debt payments and low paying jobs, dream of being able to file for bankruptcy and discharge their debt.

While they will certainly be able to discharge their credit card, car, and most other types of debt, the one debt they are likely to fail at discharging is their student loan debt.

Bankruptcy lawyers and attorneys, who represent Main Street clients that file for bankruptcy, told in a resounding chorus that it is difficult and rare to see college loan debt discharged in court.

John W. Hargrave of Hargrave Law, told that he informs his clients that they should assume their student loan debt will not be discharged.

He has made the push to have a client’s student loan debt discharged only once in his career and that was for a person who developed profound mental problems which caused her to go on Social Security Disability in her 30’s. In this unique and rare instance, the college loan agency did not oppose the filing.

As stated, this was a unique and rare incident and present bankruptcy laws often do not favor student loan debt holders.

The Present Bankruptcy Situation

Currently, the law requires a student borrower to face “undue hardship” before their college-related debt will be absolved through bankruptcy. However, the law remains ambiguous as to what “undue hardship” actually means. As a result, defining that term is left up to individual judges, which some believe leaves room for arbitrary and biased decisions.

Since the overwhelming majority of student loan borrowers are of both able-body and mind, and since most are able to perform a job that earns them at least minimum wage, only a miniscule amount of student debtors ever convince a judge to grant their request for a discharge.

In today’s economy, however, borrowers are working multiple low paying jobs and struggling against low employment growth amid a rising cost of living. But as the economy and times change, the law seems to be slow to keep up.

Changing Laws

Attorney David P. Leibowitz, founder of Lakelaw, said that able-bodied people have low probabilities of getting their student loan debt discharged, but it is still not entirely pointless to try. However, they should be pursuing much more viable methods of dealing with their college loan debt.

He is in favor of developing long-term savings and payment plans where an individual’s college loan debt is systematically reduced by automatic deductions at a level agreed upon by the borrower and lender. Such agreements would clearly benefit both parties.

Of course, this isn’t an option for everyone.

In fact, one of his clients was granted a student loan discharge after she became a victim of a gang rape. The judge agreed that her post-traumatic stress disorder prevented her from being able to function in the workplace. However, the typical underemployed college loan borrower will not get a discharge.

The courts seem to be changing their minds though.

“Some students are getting partial discharges now that weren’t able to before,” said Leibowitz.

He noted that it is still a case-by-case matter and that student loan borrowers shouldn’t hold their breath.

He recently had a client who borrowed money for college in Sweden and was curious if the Swedish college loans could be discharged. They could not since a foreign state is considered a governmental authority and US courts had no legal right to discharge the client’s international debt.

No stranger to student loan borrowing, Liebowitz himself paid for his education with a $1,350 college loan in 1970. He paid it off in one year after graduating, a fairytale for many current borrowers who struggle with making payments through multiple jobs in the slow economy. Even though tuition in 1970 was far less than present day amounts, Leibowitz offered wise advice to college loan borrowers approaching graduation.

“I would tell student loan borrowers that they need to sacrifice whatever they are doing to pay that loan off whenever possible,” he said. “Its a permanent mortgage on themselves. They have to take a second job and do whatever they can to pay it off.”

No Escape for College Loan Borrowers

Michael Duffy of Duffy Law told that the provisions for discharging college loan debt have been strengthened over the years. Courts now use a “hopelessness test” that is essentially proving that a borrower has no ability to do any job, usually because of a disability.

“As is obvious, it is very difficult to escape student loan debt with a bankruptcy discharge,” he said. “When you do, it’s probably not something you’d want to contend with anyway because being dead or disabled is probably worse than your debt, no matter how much you owe.”

Duffy believes that even though debtors rarely try to discharge their student loans, they are not entirely at fault since bankruptcy lawyers tend to avoid even trying to include college-related debt in bankruptcy filings. This is to avoid aggravating trustees and judges who are likely to think that the lawyers are simply wasting the court’s time.

Surprisingly, however, Duffy actually supports more college loan borrowers attempting to get their debt discharged — but ironically it may prove too costly for most.

“It costs money to litigate an issue, so a distressed debtor is usually not able to afford the cost of litigation that is unlikely or uncertain to succeed,” he said. “If the debtor wishes to contest their student loan dischargeability, that usually increases the cost of litigation, and debtors are unwilling to proceed.”

There still may be a glimmer of hope for student loan borrowers: state laws.

Since much of bankruptcy law is state law, certain areas of the country are likely to have better shots at getting their college loans discharged. Duffy emphasized that this is why it is so important to speak with a local bankruptcy attorney, especially since the limits of the law are not entirely clear.

Even though state law is very influential, one constant in all bankruptcy cases featuring student loans is the Brunner Test. The test examines a borrower’s level of wealth or poverty, persistence of poverty, and past good faith efforts to repay their college loans. Courts do tend to assume that borrowers will come out of poverty at some point and that any able-bodied individual will eventually be able to find some kind of job. Duffy remarked that this is still an unclear legal area, which could be why so many borrowers fail to come forward to at least try their hand at discharging their debt.

“Most clients now in fact know coming in, before I even speak to them, that student loans are generally not dischargeable,” he said. “It is not even something we need to discuss much because most people follow their disclosure of college loan debt with a statement to the effect that they know it is not dischargeable. The awareness is that ubiquitous.”

The Iron Wall of Bankruptcy Law

Richard Parker, an attorney with Parker, Butte and Lane told that an “Iron Wall” is preventing student loan borrowers from discharing their debt.

He defined the “Iron Wall” as the outdated interpretation of bankruptcy law.

“The courts interpreted the law about 30 years ago, even though circumstances have changed in the past 30 years,” he said. “They are still following their old decisions from that era and only in the past few months have some courts started questioning whether or not they should keep to the old standards from that time. Many courts are choosing to re-examine the standards.”

Parker has tried several college loan bankruptcy cases, including a 70-year-old woman who was living on Social Security, and a law school graduate who became schizophrenic prior to taking the bar exam. The first case successfully saw the woman’s college loans discharged while the latter case did not.

In another example, a husband and wife had medical problems but both earned high incomes. The judge ruled to have their college loan debt cut in half and to be repaid over 10 years without interest.

While Parker would never turn away a client who wanted to try discharging their student loan debt, he urges all clients to consider government-sponsored repayment options if they borrowed federal student loans. He advises another approach for private college loan borrowers though.

“Depending on the particular case, people with private student loans have some options outside of bankruptcy and they should see a knowledgeable attorney to see what rights they have,” he said. “The main problem is that the litigation required for a hardship discharge of college loan debt is very expensive. As a result of that high cost and the uncertain outcome, other options are usually pursued for people with private student loans.”

Society’s Student Loan Blame Game

Timothy R. Tarvin, Associate Professor at the University of Arkansas told that changing our existing laws isn’t exactly the best method for addressing the problem of student loan debt.

“Blaming the bankruptcy process for declaring that the debtor cannot pay the student loan is like blaming the coroner for the death of the corpse,” he said. “The process is merely designed to reveal whether the debtor’s financial condition will permit repayment over time. If the debtor cannot pay, then society’s interest is better served by acknowledging that this person’s loan will be among the college loans that cannot be repaid.”

Tarvin detailed that Congress is fully aware that out of the 0.1 percent of total borrowers who try to discharge their student loan debt, less than half of those filings will be granted.

He urges society to accept that loan applicants who are prone to a future default cannot easily be identified and that student loan default rates compare very favorably to default rates seen in other areas of lending.

“For example, residential foreclosure defaults have been particularly high during the Great Recession,” he said. “I would support changes in federal law that would make it easier for able-bodied college loan borrowers to ‘repay’ their loans or ‘discharge’ their loans through public service opportunities that meet strategic needs within our society. We do that to some extent now, but we could do more.”