Student loan borrowers are defaulting yearly -- how can we fix it?

Over a million borrowers defaulted on student loans last year. Many of those carrying this debt file for bankruptcy. In fact, an estimated one-third of bankruptcies involve student loans. But what many people might not know is that in bankruptcy, student loan debt is rarely forgiven. One researcher found that of over 230,000 student-loan borrowers who filed bankruptcy in 2007, under 450 — less than 0.2 percent — even tried to discharge their education loans. 

Presidential candidate Beto O’Rourke just proposed a large-scale debt-forgiveness program to help address the problem. Fellow candidates Sens. Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.) already offer such programs. But such relief will come, if at all, after the presidential election. In the meantime, bankruptcy should be a more readily available option for truly overwhelmed borrowers.

Congress is considering bills proposed by Warren and Sen. Richard Durbin (D-Ill.) and by Reps. John Katko (R-N.Y.) and Jerrold Nadler (D-N.Y.) that would make it easier for borrowers to escape, or discharge, student loans in bankruptcy. Recently, the House Judiciary Committee held hearings on student loan bankruptcy.

The bills would eliminate a requirement that applies to student loans and not to any other type of debt: To get a discharge, the student-loan borrower must undertake the daunting task of suing the creditor within the bankruptcy and proving that repayment would cause the borrower “undue hardship.” 

By severely restricting bankruptcy relief, the undue-hardship requirement undercuts the basic purposes of the student loan programs: equal access to higher education, benefiting society through educating the population, and helping students.

Excessive debt can undermine access to education. Research has shown that high undergraduate borrowing is associated with lower graduation rates and with not pursuing further education. 

Bankruptcy can help tear down this barrier. It is a fundamental premise of American bankruptcy law that bankruptcy discharge is a powerful remedy for discouragement caused by unmanageable debt, and that notion applies fully to education debt. 

The undue-hardship requirement also can interfere with education’s benefits to society. In a recent Florida case, the debtor worked at a Salvation Army shelter as a counselor to battered and abused women. According to the record, she was “at the top of her profession” and “unlikely to find other work in her field that would pay more.” 

The court refused to grant relief, no matter how low her standard of living. According to the court, a debtor cannot claim undue hardship if she “choose[s]” to work only in the field in which she was trained. The court effectively told the debtor to abandon her successful, if lower-paying, career to try to make more money to pay loans. It interfered not just with her own career choice, but with society’s ability to benefit from her education.

Finally, the undue-hardship requirement transforms an intended benefit into a high-stakes gamble. Congress intended borrowers to repay out of increased earnings, not to suffer because of failed educational investments. 

Of course, student loans can help borrowers by making education possible. But loans can also harm students. Researchers have found links between education debt and lower income, net worth, and probability of owning a house or car, as well as self-reported mental health, life satisfaction, and well-being. 

The harms can outweigh the benefits. For example, one bankrupt debtor borrowed over $50,000 for an information management master’s degree, could not find a job in the field, and worked as a telemarketer. The gamble did not pay off for him. 

Congress should enact legislation, such as that under consideration, to alleviate or eliminate the “undue hardship” requirement that obstructs bankruptcy relief for overwhelmed student borrowers. But even if Congress does not act, other actors should step in to limit the harm caused by the undue-hardship requirement.

The Department of Education makes the rules governing student loans issued under federal programs — the large majority of student loans outstanding. The department is considering changing those rules. It should, as others have suggested, adopt a policy of agreeing to discharge under certain defined circumstances that indicate severe hardship and inability to pay, such as when the debtor is disabled and has an income under 150 percent of the poverty level. By sparing such struggling borrowers the hassle of litigating a case in bankruptcy court and by providing clear rules, such a decision could help thousands each year. 

The courts have broad latitude to interpret “undue hardship.” They should move toward granting discharge more consistently and freely. For example, they should stop insisting that debtors abandon callings at which they have achieved success so that they can repay debts. Further, courts should allow discharge when the borrower cannot repay the loans within a reasonable time, such as 10 years, while maintaining a lifestyle well above the poverty level.

Thus, there are several ways to mitigate the undue-hardship requirement’s interference with achieving the student-loan programs’ goals. With over a million borrowers defaulting each year, the need for action — one way or another — is urgent.

[Cross-posted from The Hill]