Student Debt Forgiveness Needs Structural Change

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When a New York bankruptcy judge issued a ruling in January forgiving a U.S. Navy veteran’s $220,000 in student loan debt, the reaction in the media was understandably significant. Judge Cecelia G. Morris determined that Kevin Rosenberg satisfied an incredibly stringent legal test implemented in the 1980’s allowing, in rare cases, the discharge of federal student loan debt in bankruptcy.  In fact, the so-called Brunner Test is so stringent, and so rarely used, that most people share the common misconception that student loan debt is impossible to discharge in bankruptcy.  It is not impossible, just very, very hard.  For Mr. Rosenberg, the judge determined that paying back this debt would represent an undue financial hardship.  Unfortunately, though heartwarming and encouraging, this story represents an anomaly in student debt forgiveness and is not the new normal for student loan borrowers.

The growing problem of student loan debt – which has reached an all time high of $1.6 trillion – combined with the ambiguity and difficulty of the Brunner Test – highlights the need for substantive policy changes to federal bankruptcy laws. Judge Morris’ ruling is singular and sets no precedent.  In the absence of any changes to the law, it will sadly not cause a ripple effect that results in other bankruptcy judges across the country forgiving student debt for the millions of Americans who have outstanding student loans and are experiencing financial hardships.

The balance of student loans at question in this case makes it quite rare. Currently, only about 1 percent of student loan borrowers carry balances greater than $200,000, making this case the exception to what nearly 45 million Americans struggle with on a day-to-day basis. For example, Freedom Debt Relief clients with outstanding student loans hold about $40,000 in student debt on top of close to $30,000 in other unsecured debt. Without clear guidelines for discharging federal student loan debt in bankruptcy, these individuals remain in limbo and will continue to choose to avoid bankruptcy given the significant legal fees associated with filing.

It would not be wise for someone with substantial student loan debt to try to solve it by playing the lottery.  Similarly, it would not be wise to try to solve it by filing for (and paying for) bankruptcy in the hope that the student loan debt will be forgiven. The Brunner Test states that in order for student debt to be forgiven, the borrower must show that (1) they cannot maintain a minimal standard of living, (2) their circumstances are likely to continue for a significant period and (3) they have made good-faith efforts at repayment. Each requirement is quite vague, and the difficulty in convincing a judge that a borrower meets all three criteria is a primary reason why federal student debt forgiveness through bankruptcy is so rare

Because of this uncertainty, student loan borrowers in the midst of financial hardship cannot possibly know whether they meet the Brunner Test until after they have incurred significant legal expenses.

While many of our clients may not satisfy the current standard for student loan forgiveness, recent surveys that we have conducted make clear that their debt creates a significant burden, and that something must be done to alleviate it. A majority of our clients with student debt said they cannot save any money because of the cost of their college education.  And nearly 70 percent said it has made them feel overwhelmed about their financial situation. Even though their student loan balances may pale in comparison to the Rosenberg case, it is clear that tens of thousands of dollars in student loan debt presents a clear and present financial danger for these borrowers and their families.

While we should be happy for Mr. Rosenberg, the ruling is not cause for broad celebration, but rather a wake up call to the burden of student loans, and the inability of current bankruptcy law to adequately address the problem.  In fact, the non-dischargeability of student loans debt is likely contributing to the problem: if loans are non-dischargeable, lenders may feel empowered to let people accumulate more and more debt.

Bankruptcy has been a principle of English common law for almost 500 years.  It provides overburdened individuals and businesses with a path to a fresh start, while balancing the needs of creditors and lenders.  Before bankruptcy was societally accepted, the alternatives were debt slavery and debtor prisons. By limiting Americans’ ability to discharge student loan debts in bankruptcy, we are leaving many people in modern day, virtual debtor prisons, with no way to get out.  

Andrew Housser co-founded Freedom Financial Network in 2002 and Bills.com in 2005. Andrew sits on the board of directors of several startup companies as well as two independent school boards.