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What to Know About Possible Bankruptcy Rule Changes for Student Debt

Courtney Nagle

Student loans are a hefty burden for many Americans.

There are around 44 million borrowers with student debt, according to a 2017 report from the Consumer Financial Protection Bureau. Outstanding student debt sits at about $1.4 trillion, with nearly 11 percent of debt that was 90 days or more delinquent or in default at the end of March 2018, according to the most recent report by the Federal Reserve Bank of New York. So the burden is common ground for many people, to say the least.

In recent years, it's been almost impossible to get a court to discharge student loans in bankruptcy. However, while difficult, student loans have been discharged in bankruptcy before. When loans are discharged, it means the borrower is no longer legally required to repay them.

The HIGHER ED Act, H.R. 5549, introduced by Democratic Congressman Peter DeFazio from Oregon in April, would make significant changes to bankruptcy rules regarding student loans and may provide relief for some borrowers. The proposed legislation would broaden the definition of "undue hardship," the standard used to determine if a debt is eligible for discharge.

[Read: Understand Discharge Rates for Defrauded Borrowers.]

To date, Congress hasn't defined undue hardship and has left it to courts to decide on a case-by-case basis. But momentum is building with the Trump administration and in Congress to define undue hardship for student loan borrowers.

Earlier this year, the Department of Education issued a request for public comment to collect data and feedback on whether there's a need to modify how undue-hardship claims by student loan borrowers in bankruptcy are evaluated. The Education Department has expressed concerns that the undue hardship standard in its present form is discouraging borrowers from filing for bankruptcy.

Evidence that supports the concern can be found in a study by Jason Iuliano at the University of Pennsylvania Law School.

Iuliano found that nearly 40 percent of borrowers who include their student loans in their bankruptcy filing ended up with some or all their student debt discharged, but only 0.1 percent of people who filed for bankruptcy attempted to discharge their student loans. The study suggests that many student loan borrowers who are filing for bankruptcy often don't attempt a student loan discharge since it's challenging to meet the requirements used by most circuit courts.

According to the National Consumer Law Center, all federal courts of appeal except the Boston-based 1st U.S. Circuit Court of Appeals and the St. Louis-based 8th U.S. Circuit Court of Appeals have adopted what's known as the Brunner test to define undue hardship. It's based on three factors students must prove:

1. Would you be able to maintain a minimal standard of living if you had to repay the loan?

2. Are the financial difficulties you face temporary, or are they expected to continue for several years?

3. Have you made efforts to keep up with your student loan payments before filing for bankruptcy?

Borrowers must be able to prove the student debt is making it impossible to support themselves and their family and their financial situation is not expected to improve for several years.

[Read: How to Avoid Common Student Loan Complaints.]

The Department of Education is currently re-evaluating these criteria and developing guidance on determining when a student is experiencing undue hardship. It's also looking at whether to change the weights of each factor and make student loan discharges more accessible for borrowers who need relief.

There are arguments for both sides of this issue. Opponents fear that making discharge easier could put student loan programs in jeopardy and that people will game the system and run up debts with no intention to repay. But consumer advocates support the change, saying there are a lack of options for struggling student loan borrowers.

These advocates hope that by changing the definition of undue hardship, more qualified student loan borrowers will be able to get debt relief when filing bankruptcy by being able to include their student loans. Whether this change will take place or not is still unclear.

[Read: Speak Up About Student Loan Consumer Protections.]

For borrowers who are struggling to make their payments and headed into default, here are a few tips to consider with the current rules.

Review the Education Department's guidance on bankruptcy. The Department of Education developed guidance for borrowers in 2015 on whether they would be likely to qualify for a student loan discharge through bankruptcy. The guidance provides hypothetical examples of several scenarios where it would be likely. It's important to do your research and use all of your resources.

Talk to your lender. Federal student loans come with income-driven repayment plans, deferment or forbearance, and sometimes loan forgiveness. If you are struggling to figure out if there's a good option for you other than bankruptcy, the Student Loan Ranger recommends reaching out to your servicer, lender or a nonprofit credit counselor.

They can evaluate your specific situation and explain what options you have. There may even be a hardship program you don't know about.

Courtney Nagle is the digital and social media specialist for the National Foundation for Credit Counseling. She oversees content creation for blogs, manages the organization's social media channels and engages with consumers to help increase financial literacy and raise awareness of the debt-relief resources NFCC member agencies offer. She graduated from Virginia Commonwealth University with a Bachelor of Social Work.