More and more student borrowers are forgiving their debts by filing for bankruptcy

More people with federal student loans have been able to discharge their debt in bankruptcy court thanks to a Biden administration policy change announced last November.

In fall 2022, the U.S. Department of Education and the U.S. Department of Justice released updated bankruptcy guidelines to make it easier for struggling borrowers to have their student loans discharged before the courts. Previously, it was difficult, if not impossible, to get rid of your student loan debt through a normal bankruptcy process.

“I am pleased that our one-year review indicates that our efforts have made a real difference in the lives of borrowers,” Associate Attorney General Vanita Gupta said in a statement Thursday.

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During the first 10 months of the new policy, student borrowers filed more than 630 bankruptcy cases, a “significant increase” from recent years, the departments said.

“The vast majority of borrowers requesting a discharge received a full or partial discharge,” they said.

Outstanding student debt in the United States exceeds $1.7 trillion, and approximately 7% of student loan borrowers have balances greater than $100,000. Even before the Covid-19 pandemic, some 10 million borrowers were delinquent or in default.

Student loans have long been treated differently from other types of debt in bankruptcy courts, drawing criticism from legal experts and consumer advocates.

In 2018, Federal Reserve Chairman Jerome Powell said he was “unable to explain” why student loans could not be repaid in bankruptcy. Powell also warned that rising debt could slow economic growth down the road.

The difficulty in discharging student loans in bankruptcy dates back to the 1970s, when lawmakers added a stipulation that student loan borrowers had to wait at least five years after repayment began to file for bankruptcy. The move addresses concerns expressed by policymakers and experts that students would accumulate many loans and then try to get rid of them after graduation.

Those fears were greatly exaggerated, said higher education expert Mark Kantrowitz.

“Only borrowers facing extreme financial hardship seek to have their debt erased,” Kantrowitz said. “A bankruptcy discharge ruins your credit for seven years, preventing you from getting credit cards, car loans and mortgages.”

However, in 1990, the waiting period was increased to seven years. And the rules changed again nearly a decade later, requiring people with federal or private student loans to prove that their debt poses an “undue hardship” to discharge them. Congress, however, has never clarified what the term means, and lawyers and advocates have complained that the uncertainty led to injustice in the courts.

“The new policy represents a softening of the hardline stance on federal student loan forgiveness,” Kantrowitz said. He added that courts are now moving toward “treating student loans like other debts.”