More people with federal student loans will be able to discharge their debt in bankruptcy court thanks to a policy change announced by the Biden administration last November.
In the fall of 2022, the US Department of Education and the US Department of Justice released updated bankruptcy guidelines to make it easier for struggling borrowers to erase their student loans in court. Previously, it was difficult, if not impossible, for people to discharge their education debt in a regular bankruptcy proceeding.
“I am pleased that our one-year review shows that our efforts have made a real difference in borrowers’ lives,” said Assistant Attorney General Vanita Gupta in a statement on Thursday.
In the first 10 months of the new policy, student loan borrowers filed more than 630 bankruptcy cases, a “significant increase” from recent years, the departments said.
“The vast majority of borrowers seeking discharge have received full or partial discharges,” they said.
Outstanding student debt in the US exceeds $1.7 trillion, and about 7% of student loan borrowers have balances of more than $100,000. Even before the Covid-19 pandemic, some 10 million borrowers were delinquent or in default.
Student debt had a high bar for bankruptcy discharge
Student loans have long been treated differently from other types of debt in bankruptcy courts, drawing criticism from legal experts and consumer advocates.
In 2018, Federal Reserve Chairman Jerome Powell said he was “at a loss to explain” why student loans couldn’t be discharged in bankruptcy. Powell also warned that rising debt levels could slow economic growth over time.
The difficulty of discharging student loans in bankruptcy dates back to the 1970s, when lawmakers added a provision requiring student loan borrowers to wait at least five years after starting repayment to file for bankruptcy. The move came in response to concerns raised by policymakers and pundits that students would rack up a bunch of loans and then try to get rid of them after graduation.
Those fears were largely overblown, says higher education expert Mark Kantrowitz.
“Only borrowers facing extreme financial hardship seek debt relief,” Kantrowitz said. “A bankruptcy discharge ruins your credit for seven years, preventing you from getting credit cards, car loans and mortgages.”
In 1990, however, the waiting period was increased to seven years. And almost a decade later, the rules changed again, requiring people with federal or private student loans to prove that their debt poses an “undue hardship” in order to discharge it. But Congress never spelled out what that term meant, and lawyers and advocates complained that the uncertainty led to unfairness in the courts.
“The new policy represents a softening of the tough stance on discharging federal student loans,” Kantrowitz said. He added that the courts were now moving in the direction of “treating student loans like other debts”.
