Supreme Court could change test for student loan discharge

Discharge of student loans difficult under current standard

College is such a time of hope. A student embarks for university and, literally, a new life. Even the name "university" suggests endless possibilities. In the last 15 to 20 years, unfortunately, what many students have found instead of endless possibilities was endless debt, potentially stretching out in front of them for the rest of their lives.

And this is because student loans are different. With most debts, even a mortgage or something as trivial as gambling, you can discharge your debt in a bankruptcy filing and walk away to a new beginning and a fresh start.

Not so with student loan debt. At one time, it was possible to discharge a student loan, just like most other debts. But then, Congress got word of what can only be called an urban legend. It was suggested that some medical school and law school students were running up large student loans and then, as soon as the graduated, filing for bankruptcy protection and discharge all of their student loans. In essence, they received a free education.

A scary story indeed. Except for one thing. It never happened. Back in the 1970s, when you could discharge student loans, the GAO noted that only 0.5 to 0.75, or less than one percent of student loans were discharged in bankruptcy shortly after graduation. Congress acted on anecdotal stories and changed the law with no real evidence of a need.

First, they set a 5-year repayment period before you could discharge a school loan. Then they made it 7-years, and finally, the limited it only to cases of "undue hardship," which they did not define.

A federal court in 1987 did that for them. It created the Brunner Test, named after the case. This test has become the definition of undue hardship in many jurisdictions. It is a three-part test, and it is often difficult for borrowers to "prove" that they will never be able to improve their earning capacity enough that it would allow them to pay off their student loans and still maintain a reasonable lifestyle.

One in four Student Loan Borrowers in Default

The credit industry strongly opposes an easing of the restrictions on discharging student loans, claiming it could affect the stability of the Department of Education's loan programs. The fallacy of that argument is that for many of these borrowers, repayment is simply not an option.

Twenty-five percent of these loans are already in default, and with penalties and interest piling up, the balances will keep growing. These borrowers will never earn enough income to maintain a basic standard of living and be able to afford loan repayments.

This means that money will never be repaid. It would be better to allow these borrowers the ability to obtain a discharge and the fresh start promised by the bankruptcy code. Many of these debtors are trapped, and will spend a significant portion of their life's income attempting to repay these overwhelming loans, sometimes in careers unrelated to their degree.

$260,000 in debt, in his 50s, unemployed and living with his mother

For many that alone those circumstance would seem sufficient to quality as "hopeless." If he could afford to make $30,000 a year in payments, he would reach retirement age before he would have the loans repaid.

But he has had alcohol abuse issues and is unemployed. It is unlikely he would be hired by anyone, given those issues, but the Court of Appeals for the Seventh Circuit did not find his situation compelling enough to meet the undue hardship test.

His case could be heard by the U.S. Supreme Court, and that Court could change the test for undue hardship. Some have argued a better test would be a totality of the circumstance test, which would allow judges more discretion in examining the personal situations of debtors.

The Court has not accepted the case, and it would likely be next summer before a decision arrives if they do take the case. Nevertheless, if you are struggling with student loans, a bankruptcy may still provide significant relief, depending on the other debts you may be carrying.

A bankruptcy attorney can explain how a Chapter 7 or Chapter 13 works and if such a filing could help your overall economic situation.