Bankruptcy and Student Loan Debt: What You Need to Know

Bankruptcy and Student Loan Debt: What You Need to Know
Bankruptcy is a positive change in many people’s lives, a turning point when they begin a path to a new financial future and get rid of burdensome debt. Filing for bankruptcy can discharge debts from credit cards, car loans, and unpaid medical bills. But there’s one type of debt that is notoriously difficult to get rid of: Student Loans.

Why Student Loan Debt Is Easy to Get – And Difficult to Get Rid Of

Bankruptcy and student loan debt are not happy bedfellows. While it’s not impossible to discharge debts from student loans, Congress has made it extremely difficult. Student loan debt is similar to mortgage debt when it comes to bankruptcy proceedings, because there is a widely shared belief that a college education and homeownership are good for society. Higher education helps to create careers, build wealth, and make Americans better able to compete on the global economic landscape.

Uncle Sam wants as many people as possible to have a college education – and to make this happen, student loans must be readily accessible. In order to keep the money flowing to potential students, there are tough restrictions on bankruptcy discharge for this type of debt. The investment capital keeps flowing freely because it’s a near certainty that the money will have to be paid back.

Undue Hardship

The only way to discharge student debt in bankruptcy is by proving that repayment would be an “undue hardship” – an undefined term that is applied in very rare circumstances. It’s incredibly difficult to get rid of these types of loans. Filing for bankruptcy and student loan debt discharge rarely coincide.

A New Hope: The Murphy Case

But things may be changing. The landmark court case of Robert Murphy at the First Circuit Court of Appeals has the potential to rewrite the books. For three years, this 65-year-old man has fought for relief of $265,000 in student loans that he took out in order to send his three children to college. After losing his job in 2002, he has been unable to find work or repay the money.

Murphy’s case is forcing the court to reconsider the definition of “undue hardship.” If the federal court creates a more lenient standard, there will be ripple effects throughout the entire country. It would become much easier for people to receive a reprieve on their student debt payments via bankruptcy.

America’s Student Debt Problem

This court case about bankruptcy and student loan debt highlights the increasingly dire situation that many Americans are finding themselves in after they finish school. A college education is no longer a ticket to a higher-paying career, and many graduates are struggling to find work and repay their debts.

Currently the total federal student loan debt is $1.2 trillion, and climbing every day. Over 7 million people are behind on their student loans, and the default rate is 11.8% among borrowers in their first three years.

The Obama administration has held the line against allowing student loans to be discharged in bankruptcy. A change in the law could be devastating to the solvency federal student loan program – not to mention the $1.2 trillion price tag that would have to be paid by taxpayers or added to the national debt.

Murphy’s case is crucial for those with student loan debt, but for now: the verdict is out.

Are You in Debt?

But if you are struggling with debt, help IS available – and knowledge is power.

Download your copy of 6 Bankruptcy Myths that Could Destroy Your Finances (and What to Do Instead!).

Bankruptcy and Student Loan Debt: What You Need to Know