Last month, the Biden administration announced significant new policies that will make it easier for many federal student loan borrowers to discharge their student debt in bankruptcy.
While the new policy falls far short of the kind of bankruptcy reforms that could be enacted through Congressional legislation, advocates for borrowers have expressed cautious optimism that the changes will make a real difference for people struggling under the weight of their student loan debt.
Here’s what borrowers should know.
Student loans are hard to discharge through bankruptcy
Under the bankruptcy code — a complex set of federal laws governing the bankruptcy process — student loans are treated differently from nearly any other kind of consumer debt, such as credit card bills or medical debts.
Student loans can only be discharged if the borrower can prove to a court that repaying their student debt presents an “undue hardship.” The bankruptcy code doesn’t really define what “undue hardship” means, so it’s been left to judges, who in turn established standards and tests (that vary, to some degree, by jurisdiction). These tests can be very difficult for borrowers to meet.
To make things even more challenging for borrowers, in order to demonstrate that a borrower meets the undue hardship, they would have to initiate something called an “adversary proceeding.” An adversary proceeding is a process by which the borrower files suit against their student loan lenders in bankruptcy court to present evidence that they meet the undue hardship standard.
In most cases, the lenders (which, for federally-administered student loans, would include the federal government) will oppose the borrower. And these lenders typically have far more resources at their disposal to make the process grueling and difficult. The process is, by definition, adversarial.
While it’s by no means impossible to discharge student loans in bankruptcy under the code, the law and established process make it quite difficult. Often, only the most extreme cases prevail. And many borrowers and bankruptcy attorneys don’t even bother trying because of the burdens, costs, and likelihood of failing.
Policy changes will relax bankruptcy treatment for federal student loan borrowers
Under the policy changes announced last month by the Education Department and Justice Department, borrowers seeking to discharge their federally-administered student loans will be able to complete a self-attestation form providing detailed information about their financial circumstances.
The Justice Department, in consultation with the Education Department, will evaluate that information and determine if the borrower is able to demonstrate undue hardship. If so, the government would choose not to oppose the borrower’s adversary proceeding and will endorse a bankruptcy discharge.
Importantly, this process would not eliminate the undue hardship standard or the need for a borrower to file an adversary proceeding. But the changes will provide a potential path for a borrower not to have the federal government oppose their discharge request in that adversary proceeding.
While this would not guarantee that the borrower would ultimately receive a bankruptcy discharge of their federal student loan debt, it would make the process significantly easier for borrowers, as judges are more likely to grant a request if the two opposing parties are aligned.
Factors to be considered in student loan bankruptcy discharge request under the new policy
According to the Justice Department, officials will assess various undue hardship factors to determine whether or not it will oppose a federal student loan bankruptcy discharge. These factors, which are based on undue hardship standards established by key federal court precedents for student loan bankruptcies, will include the following:
Present ability to pay
Using IRS standards, the Justice Department will evaluate a borrower’s income and expenses. If the borrower appears unable to cover their reasonable expenses with their current income streams, they lack a present ability to pay their student loans.
Future ability to pay
Assessing borrowers’ future ability to pay their loans has always been a challenging aspect of the undue hardship test. Under the administration’s new policy, the Justice Department will assess whether the borrower’s present inability to pay is likely to continue into the future.
To do that, officials will assume that the borrower’s financial circumstances are not likely to change if certain factors are present. Those factors can include the borrower’s age, a disability or chronic injury, long periods of unemployment, a lack of a degree, or a long time spent in repayment on their loans with little or no progress in paying it down.
Borrowers who do not present one or more of these factors may have a tougher time showing that they meet the undue hardship standard, but the Justice Department will consider a borrower’s unique facts and circumstances.
Good faith efforts
The undue hardship standard requires that borrowers must have made “good faith efforts” to repay their student loans to qualify for a bankruptcy discharge. According to Justice Department guidance, the administration will “focus on objective criteria reflecting the debtor’s reasonable efforts to earn income, manage expenses, and repay their loan.”
Simply contacting the Department of Education or the borrower’s designated loan servicer regarding payment options may be sufficient to establish a good faith effort, even if the borrower did not ultimately make payments on their loan. Importantly, failing to enroll in an income-driven repayment plan is not an automatic disqualifier for the good-faith prong, as long as the borrower can demonstrate a good-faith reason (i.e., for some borrowers, even payments on an income-driven plan may be unaffordable).
Limits of new student loan bankruptcy policies
While the bankruptcy policy changes are potentially significant for borrowers experiencing true hardships, there are ultimately some limits to the scope of relief. Only federal student loans are eligible for relief under the new process. Private student loans are not covered.
Related: Could Private Student Loan Borrowers Be Eligible for Bankruptcy?
Furthermore, as noted above, the reforms do not ultimately change the undue hardship standard or eliminate the need for a borrower to file an adversary proceeding. More fundamental changes to the bankruptcy code would require an act of Congress. While some bankruptcy reform legislation has gained some bipartisan traction in the last couple of years, so far, nothing appears likely to imminently pass Congress.
Ultimately, time will tell whether the new bankruptcy policies will have a real, tangible impact. Federal student loan borrowers wishing to consult with a bankruptcy attorney regarding their rights and options can find a local consumer bankruptcy lawyer via the National Association of Consumer Bankruptcy Attorneys (NACBA), or they can contact their state or local bar association for a referral.