Student loans are a $1.2 trillion problem in the United States. Today, 7 out of 10 college graduates are leaving campus with a student loan statement in hand. Student loan debt is the second largest form of consumer debt, only behind mortgages in terms of total debt outstanding. But did you know that student loan debt is one of the only forms of consumer debt that isn’t dischargeable in bankruptcy?
Earlier this week the Supreme Court denied an appeal that aimed to discharge student loan debt in bankruptcy. Mark Tetzlaff, an unemployed business and law school graduate, asked the Supreme Court to consider erasing his $260,000 student loan tab through chapter 7 bankruptcy. In Tetzlaff’s appeal, he argued that his criminal record, depression, and alcoholism kept him from securing a job and repaying his student loan debt. The Supreme Court agreed with multiple other courts who argued that Tetzlaff did not meet the “undue hardship” necessary to discharge his student loan debt.
For decades, federally backed student loan debt has been restricted from being discharged in bankruptcy. More recently, in 2005 a law was passed that restricted private student loan debt from being cancelled in bankruptcy too. To qualify for student debt cancellation in bankruptcy, the borrower must prove to the court that they are unable to meet a minimum standard of living as a result of their student loan debt. Tetzlaff, who repeatedly failed the bar exam, was judged capable of finding employment and therefore able to meet a minimum standard of living. Tetzlaff isn’t the only student loan borrower struggling to repay their debt.
According to the Federal Reserve’s Quarterly Report on Household Debt and Credit, 11.6 percent of student loan borrowers are 90 days or more past due. Tetzlaff could have taken advantage of the many federal student loan benefit programs available, including Income-Based Repayment (IBR). IBR limits your federal student loan payments to 10 percent of your discretionary income. And, after 240 IBR payments federal student loan debt is eligible for forgiveness. Instead, Tetzlaff decided to ignore all income-driven repayment plans by making zero student loan payments.
The vast majority of the more than 43 million student loan borrowers will not qualify to erase their debt in bankruptcy. As long as bankruptcy judges continue to use a strict test, most student loan borrowers will not meet the qualifications for “undue hardship”. Student loan borrowers should consider other forms of repayment assistance, and only consider bankruptcy as a “hail mary” last resort. On the flip side, taxpayers and private student loan lenders alike can thank the courts for upholding the laws designed to protect student loan lenders.