Why can’t bankruptcy absolve college loans?

Before 1978, all college loans were dischargeable through bankruptcy. But a series of laws instituted over several decades began to limit them from being absolved through bankruptcy proceedings.

In 1978, the US Bankruptcy Code (11 USC 101 et seq) first limited a debtor’s ability to dissolve college loans through bankruptcy, but it did not outright ban the practice.

According to FinAid, only private student loans that were made by a “nonprofit institution of higher education” were exempt from discharge. This was intended to protect the National Defense Student Loan Program which preceded the Perkins Loan Program. The money from this program was lent by colleges that used a revolving fund which the federal government matched.

But in 1984, the Bankruptcy Amendment and Federal Judgeship Act made private student loans from all nonprofit lenders— such as those lenders outside of the government and colleges who lend without seeking to turn a profit—immune to bankruptcy discharge.

Then nearly thirty years later, in 2005 the Bankruptcy Abuse Prevention and Consumer Protection Act expanded bankruptcy exemption limitations to include all qualified education loans—be they from a nonprofit lender or not.

But There’s Still a Way

Despite these laws it is possible to absolve college loans through bankruptcy proceedings provided a student can prove that there is “undue hardship” preventing them from making their payments.

Due to the legal changes made over the past decades it is very difficult to convince a judge of “undue hardship.” Only very rare cases that demonstrate hopeless situations that prove there’s no room for financial advancement succeed. For example, a judge ruled in May, 2012, to discharge the college loans of a woman who had Asperger’s Syndrome, according to a report by loans.org. Her massive debt—which was in excess of $300,000—combined with her medical condition provided a reasonable argument for her claim.

As the recession drags on, more and more borrowers are falling into unemployment and underemployment. Naturally, it’s proving difficult to repay college loan debt with little—if any—income. For many borrowers their situations are worsening as their private lenders raise interest rates or levy fees against them for defaults and missed payments.

Concerned (and heavily indebted) borrowers should take comfort in the fact that reform may be over the horizon. The Consumer Financial Protection Bureau has begun pushing for bankruptcy reform for college loans. Combined with the fact that student loan debt has grown to be greater than credit card debt, it remains possible that change may soon come.