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Student Loan Bankruptcy: Not As Hard As You Think

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I just read an article from Forbes about a law student who is also a Navy veteran who had $221,000 in student loan forgiven. A bankruptcy judge granted him an student loan bankruptcy. The judge claimed the loan would “impose an undue financial hardship” on the veteran.

To be clear, as far as I see, this was not a student loan forgiveness program for a veteran. This is a student loan bankruptcy provided outside the military that removed his legal requirement to pay his student loans.

Are Student Loan Bankruptcies Possible?

The first thing that went through my mind when I read this article was “wait, people can declare bankruptcy on their student loans?” I have heard they are (next to) impossible. An article from CreditKarma illustrates the issues of student loan bankruptcies. According to the article only 0.1% of bankruptcy cases try to have their student loans discharged. Of those cases 40% of the bankruptcies include at least a partial discharge.

In my mind, student loan bankruptcies went from as rare as leprechauns to something that, if you were to attempt it, I would not even classify it as uncommon. Granted, the cases that actually tried to discharge student loans may have circumstances that make student loan forgiveness possible and the rest may not not fit the bill.

The Brunner Test With Student Loans

The judge ruled that the student loan fits the Brunner Test which has this standard:

  1. The borrower has extraordinary financial hardships.
  2. The hardships will extend throughout the term of the borrower’s loan.
  3. The borrower has made real attempts to repay the loan.

The Brunner Test is commonly used to determine if people should have their debts forgiven. It is rarely applied to student loans. The judge also added that this case should illustrate that student loan bankruptcies are possible (not common, just possible). The judge also added that borrowers should attempt to seek out bankruptcies in student loans.

Is The Borrower Responsible For Paying Back The Debt?

Debts are contracts. Both parties agree to certain terms, the loaner agrees to give the borrower money and the borrower typically agrees to pay the money back with interest. So student debt owners can bring borrowers to court if the borrowers do not pay, much like the veteran. The loaner can pursue legal action, but none is guaranteed. If a judge says that a contract does not need to be upheld, there is very little the loaner can do.

I think people forget that contracts are only legal if they are upheld by legal institutes and figures. A law or policy is only as powerful as its enforcement. Therefore, a student loan borrower is not always responsible for paying back their loans, but only if the responsibility is legally removed by a judge or another form of legal authority.

Consequences Of Student Loan Bankruptcies

Loaners are more willing to loan money if there are guarantees that the loan would be paid off. If the guarantee no longer exists, loaners will be less likely to loan out money. Believe it or not, but a bankruptcy does not guarantee that that the government will reimburse the loaner. Therefore, loaners are all but guaranteed to lose money in the bankruptcy. The question is: should the practice of student loans be more restrictive?

The Purpose Of Student Loans

Student loans were not designed to benefit people who could easily pay for college (obviously). Student loans provide opportunities to disenfranchised people who cannot normally afford higher education. But are these opportunities worth it? Is it immoral to enable people to waste their efforts to chase dreams that are unreachable due to personal reasons? Do student loans have a purpose if there is no return of investment? Should loaners only provide student loans to people who will succeed? How do loaners determine who will succeed?

No one has a solid answer to these questions. There is no way to predict a person’s success better than the success of a company or a piece of real estate, there is always risk. If loaners have to take on more risk from their loans, they will calculate how to minimize risk. That will include leaving people behind, which will invite discrimination leading to further disenfranchisement of already disenfranchised demographics.

Student Loan Bankruptcies Are Not The Answer

I never recommend bankruptcy. But I especially, do not recommend student loan bankruptcy, even when it is possible. Bankruptcies are essentially legally upheld renegotiated payment plans that require legal fees, extensive effort, and damage to your credit score. Most bankrupted loans that are not backed by a government almost always end with both loaners and borrowers receiving the short end of the stick.

The entire point of people loaning money is because they want a rate of return on their investment. Would you continue to invest (or loan) money to an investment if they continually fail to hold up their bargain to help you make money? No, that is pretty much a falling knife, you would pull out your money, and many investors would too.

Fewer Opportunities For Everyone

If you receive a mortgage that is not backed by the government and go bankrupt, the loaner will not make as much money as they hoped. Whether it is because of legal fees or having to settle for a lower payment. Whether the loaner is taking unfair advantage of you or not, the bankruptcy will force them to take further consideration of their lending practices. Some people who are looking for houses may have a harder time finding mortgages from the same loaner via higher interest rates, and higher rates of rejection. People may lose out on getting the home they want, maybe even not get a house.

For student loans, if the same happens, loaners would normally decrease the number of loans they could out. However, around 92% of student loans are backed by the US Dept of Education, meaning that the loaner does not always take the risk. Instead, the government pays for the loans, or in other words the taxpayers. Therefore, the taxpayers are the loaners (although not as willing). Taxpayers do not want to vote for politicians who will raise their taxes. In other words, taxpayers are not as willing to loan out as much to students. Don’t believe me, ask yourself who should pay for other people’s student loans? I believe there is a 99% chance you do not belong in the demographic you said should pay for it.

Final Thoughts

Recent news does show that student loan bankruptcies are in fact possible. While student debt is a shackle for many people, it should not be something removed easily by bankruptcy. You should never see bankruptcy as anything more than a last resort, much less aim for bankruptcy in any situation. However, using bankruptcy usually ends with loaners cutting back on lending. This is not a house we are talking about where a good alternative (rent) is easily available, this is higher education, the chance to not only pursue dreams, but to provide skills, intelligence, and creativity to secure the future of the world.

If too many student loan bankruptcies occur, many people will lose out on the potential to further their education that many of us have had.

Author: Papa Foxtrot

Most of my life I was careful with money and learned where I should invest it. I was very lucky to have parents who taught me financial literacy when I was young. Unfortunately, I am very lucky because many people lack the financial literacy I know. The purpose of Forge Your Wealth is to teach people who are just starting out in life how to obtain their wealth or anyone who just realized they may need to learn more to handle their finances. I currently have a PhD in biochemistry, just started a job in industry (will not disclose where exactly for personal and professional reasons) and am currently married to the love of my life. I am one of the lucky few people in America who graduated with no student debts, my wife was not. Over the series of a little over 3 years we paid for our wedding with no debt and paid off her federal student loans.

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