- Judges have changed their reading of how private student debt should be treated in bankruptcy.
- The report by the Student Borrower Protection Center is the first estimate of how much private student loan debt may be readily dischargeable in bankruptcy.
- SBPC estimates that about 2.6 million borrowers could be eligible for relief.
If you’re struggling to repay your student loans, you may be entitled to automatically get rid of them in bankruptcy if you’re one of about 2.6 million borrowers with certain types of privately-issued loans, according to a new analysis by the Student Borrower Protection Center.
The SBPC, a Washington D.C.-based advocacy group for student borrowers, estimates that a total of about $50 billion of such loans are out there, and they may be as easy to cancel in bankruptcy as credit card debt or other consumer loans.
For many years, conventional wisdom had held that student loans were impossible to get rid of, even in bankruptcy. But bankruptcy courts started to rethink this over the last six years thanks in large part to the work of Austin Smith, an attorney specializing in student loans who Insider profiled in May 2021.
Smith argued that bankruptcy judges had been misinterpreting the law in a way that benefits lenders. Starting in 2016, bankruptcy judges began to agree with his legal interpretation in case after case and many of his clients were able to cancel a portion of their student loan debts. Despite the legal victories, it wasn’t clear how many borrowers might be entitled to obtain relief in bankruptcy court under this new interpretation of the federal bankruptcy code.
The SBPC’s report – written with assistance from Smith – is the first attempt to add up the scope of the problem. About 420,000 Americans applied for bankruptcy protection in the twelve months ending September 2021, though that number was significantly lower than previous years, when there were around 750,000 filings.
While the SBPC cautions that its figures are only a rough estimate, its findings suggest that an alarming number of borrowers may be unaware that they are entitled to bankruptcy relief for some of their private student loans if they struggle to repay them.
“The law was written in such a way that no one could figure out what it meant, at least certainly no one without a law degree,” Smith said in an interview. As a result, “borrowers were left alone to fend for themselves.”
The confusion centers around “private” student loans – educational debt that’s not made or insured by the federal government. Private student loans account for 8% of Americans’ total student loan debt, or about $140 billion of the $1.75 trillion owed, according to statistics compiled by the Education Data Initiative. The remainder is federal student debt.
Whether their loans are private or federally-backed, borrowers who declare bankruptcy can have them canceled like any normal debt if they prove that paying them off would impose an “undue hardship.” Typically, that requires a borrower to demonstrate that they cannot maintain a minimal living standard, that their circumstances are unlikely to change, and that they’ve made good-faith efforts to repay their loans.
But borrowers who owe privately-issued loans have even more exceptions they can rely on. That’s because “private” student debt isn’t defined anywhere in the U.S. bankruptcy code. Instead, the law refers to “qualified education loans” – those made for direct education expenses like tuition, books, room and board at accredited colleges and universities. Private student loans meeting that definition – such as a $20,000 loan that’s used to pay tuition at a four-year state university – can’t be canceled in bankruptcy, absent a showing of “undue hardship.”
Smith discovered that many struggling borrowers whose cases he took on owed loans that didn’t meet the strict “qualified education loans” criteria set out in the law. They included so-called “direct-to-consumer” loans in which lenders often fronted borrowers more money than they needed for direct education expenses, loans for non-accredited colleges (such as for-profit and vocational training schools), or consumer loans to fund living expenses for law school students studying for the bar exam. Over the years, Smith has successfully convinced judges that such debts aren’t “qualified education loans” and can be canceled in bankruptcy.
The SBPC noticed Smith’s string of victories and sought to scope out how many borrowers might be in a similar situation. The student loan help center was founded in 2018 by a team of former regulators from the Consumer Financial Protection Bureau who became concerned that the agency had abandoned student loan borrowers during the Trump era. SBPC quantified how much private debt doesn’t meet the “qualified education loan” criteria by using loan origination data and other industry metrics to calculate debt used by ineligible students ($23 billion), debt used at ineligible schools ($17 billion) and debt used for ineligible expenses ($10 billion). Using average private student loan balance data, SBPC estimated that the total, $50 billion, is owed by about 2.6 million borrowers.
Despite these figures, many student borrowers often assume that any student loan is protected from discharge in bankruptcy. The SBPC blames the student loan industry for that misperception. In its report, the SBPC points to language that student loan giant Sallie Mae included in its direct-to-consumer loans, which advised borrowers that the debt was “not dischargeable” in bankruptcy. SBPC pointed out that in documents shared with investors who bought securities backed by its loans, Sallie Mae and its successor Navient Corp. made a different disclosure, warning them that they would “bear any risk of loss resulting from the discharge of any borrower of a private credit student loan.”
Courts are now making that risk a reality. In 2019, the U.S. Bankruptcy Court for the Eastern District of New York agreed with Smith’s interpretation of the law, finding that $12,567 of direct-to-consumer loans owed to Navient weren’t shielded from cancellation in bankruptcy. The borrower, Hilal Homaidan, had obtained an order discharging his debts during a 2009 bankruptcy proceeding but Navient continued to seek payments, prompting him to re-open his bankruptcy proceeding in 2017 so that a judge could rule that the loan had in fact been discharged. In July 2021, the U.S. Court of Appeals for the Second Circuit sided with Homaidan and the case is ongoing.
A spokesman for Navient declined to comment.
The Homaidan case is emblematic of a common problem, according to the SBPC: “Borrowers across the country are being ripped off by student loan companies that continue to collect on debt that has already legally been discharged by borrowers who have completed bankruptcy proceedings,” the SBPC said. “Unfortunately, in the vast majority of cases, these borrowers either assumed that their loans could not be and therefore had not been discharged, or they were directly—and falsely—told by a student loan company that they continued to owe on these debts.”
The Biden administration has taken steps to help student borrowers cushion the blow of the coronavirus pandemic. In December, the Department of Education extended the pause on federal student loan repayments by an additional 90 days – until May 1 – to help borrowers weather the financial difficulties caused by the pandemic. It was the third such extension granted by the administration since President Biden took office. And in August, the agency unveiled a new regulation to automatically forgive debts owed by federal loan borrowers who the Social Security Administration has identified as severely disabled. The agency estimated that about $5.8 billion in debt would be forgiven under that new policy, which overhauled a troubled federal loan relief program for disabled borrowers.
Helping private loan borrowers is harder. Because their debts aren’t made or insured by the federal government, policymakers in Washington have less ability to enact sweeping changes to the collection and discharge of private student debt.
Last year, Smith announced a run for Congress in New York’s 1st Congressional District to help legislate relief for borrowers. Meanwhile, Sen. Elizabeth Warren (D-Mass.) has sponsored a bankruptcy reform bill, the Consumer Bankruptcy Reform Act of 2020, which would simplify the rules by eliminating the various exemptions to discharging student loans in bankruptcy. The bill would make all student loan debt as easy to discharge as most other types of consumer debt but the fate of such legislation remains uncertain in the evenly-divided Senate.
Cezary Podkul is an award-winning freelance journalist. He was previously a reporter at the Wall Street Journal, ProPublica, and Reuters.
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