Student Loans and Bankruptcy - Something May Be Cooking

Rep. Steve Cohen (D-Tenn.), chair of the House Judiciary Subcommittee on Commercial and Administrative Law, held a hearing to initiate legislation that would alter the 2005 bankruptcy law changes.

The current bankruptcy law prevents virtually all debtors from discharging their student loan debt. At the same time, most other forms of debt, including mortgages, credit card debt, medical bills, and auto loans, can be discharged and wiped away through bankruptcy. The only exceptions are made in cases of "undue hardship", a very vague and difficult standard to meet.

In a nutshell, the law interpreting "undue hardship" was not defined by congress, varies from district to district and is up to the interpretation of bankruptcy judges. Courts generally go through long investigations to determine whether debtors have faced an undue hardship. An example of a likely undue hardship would be a paraplegic who has the inability to work or provide any income for the rest of his life. In other words, it's a very difficult standard to meet.

The current law not barring student loan discharge except in cases of undue hardship applies to both federal and private student loans. Federal student loans come with fixed interest rates, flexible payment plans, and other consumer protections that generally make them less risky for borrowers. On the other hand, private student loans aren't subject to the same rules and and may have high variable interest rates and payments. Taking out a private student loan is no different than putting the tuition and books on a credit card. The only difference is a credit card can be discharged in bankruptcy.

In 2008, an amendment to the bankruptcy code was proposed that would have allowed debtors to discharge their their private student loans in bankruptcy, as long as the loan had required repayment for at least five years. The measure failed in a 236 to 179 vote. Cohen’s bill may be modeled after the failed amendment.

This would be a huge change to the current bankruptcy laws. We'll be monitoring any bill introduced.