Bankruptcy can help with student debt

Whenever you read about the immense amount of outstanding student loan debt in this country, you invariably read that student loan debt cannot be discharged in bankruptcy court. 

Well, that's not quite the case. A discharge of student loan can be done if your circumstances are sufficiently and demonstrably dire. You also have to prove to the court that there's no reason to hope that they'll get any better for the life of the loan, according to an excellent Ron Lieber story in The New York Times.

In other words, bad luck and hard times are your lot in life, and you must convince the judge of that fact.

It didn't used to be that way. Student loan debt was dischargeable in bankruptcy before the mid-1970s. Then Congress began gradually tightening the rules for federally guaranteed student loans, and it finally eliminated bankruptcy discharge for private student loans -- including those issued by banks -- in 2005. (FinAid.org has an interesting timeline of the changes here.)

"That essentially lumps student loan debt in with child support and criminal fines -- other types of debt that can't be discharged," Kayla Webley observed earlier this year on Time.

(While programs exist to forgive or reduce federal student loan payments, those options aren't available for students who took or take on private student loan debt. That's why people who are advocating a change in the bankruptcy laws are focusing on making private student loans dischargeable in bankruptcy.)

If you borrowed it, you have to repay it -- unless you can prove to the bankruptcy judge that your student loans are causing an "undue hardship" for you and your dependents. How do you make your case? (Post continues below.)

A federal website that explains ways to have federal student loan debt canceled, forgiven or discharged explains the bankruptcy courts' three-part test (and you have to meet each and every one of these):

If you are forced to repay the loan, you would not be able to maintain a minimal standard of living.

There is evidence that this hardship will continue for a significant portion of the loan repayment period.

You made good-faith efforts to repay the loan before filing bankruptcy (usually this means you have been in repayment for a minimum of five years).

Many judges have adopted a "certainty of hopelessness" test, Lieber writes, which requires them to believe that you truly have no hope of earning an adequate living now and for years to come.

These cases can drag on for years, and the government may fight you every step of the way. (A Palm Beach Post story this week, by the way, detailed how the feds have greatly increased the number of lawsuits they file against student loan defaulters.) The Times story focuses on a 31-year-old college grad, now legally blind, who first went to bankruptcy court six years ago. He's seeking the discharge of $89,000 in student loans.

The good news is, studies mentioned by the Times show that 39% or more of undue hardship applicants are successful in getting part or all of their student loan debt forgiven. Fewer than 1,000 people try it each year, the Times says.

The only case we could find: A bankruptcy judge discharged $340,000 in student loans owed by a woman who can't work because of Asperger's syndrome.  

What do you think? Should bankruptcy be restored as an option for those unable to repay their student loans -- either private loans or those guaranteed by the federal government? Should bankruptcy standards be relaxed to help the unfortunate?

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Some don't think so, at least not for federal loans. Wrote one reader of the Times:

Many people are financially handicapped for life by no fault of their own. However, if you choose to take the risk inherent in taking out a loan, you do not fall within this group. You took a risk. You took someone else's money and agreed to pay it back with interest. Other taxpayers who did not take that money should not have to pay for you.

More on MSN Money:

• Grandma's new worry: Student debt
• Are universities unethical?
• 11 surprising student loan facts
• Student loans push up bankruptcies
• Student loans sink Mom and Dad
• Will I be able to pay back my student loans?