More student loan borrowers file bankruptcy to get their debt discharged—here’s why it should always be a last resort
Scores of student loan borrowers were dreading the end of forbearance this year, but some of them are in such dire straits, they’re going to court to dissolve their debts instead.
More borrowers are filing for bankruptcy—a move that’s become much easier since the Department of Education and Department of Justice updated the filing guidelines last year.
In the first ten months of the new policy through September 2023, student loan borrowers filed more than 630 bankruptcy cases, a “significant increase” from recent years, the departments said in a recent press release.
The departments anticipate this trend to continue.
“It is clear that this improved process is helping struggling borrowers,” said chief operating officer Rich Cordray from the Office of Federal Student Aid in the departments’ press release.
“This guidance is an important piece of our overall efforts to create a student loan system that is more humane, with affordable payments and programs that work as intended,” he said.
“In partnership with the Justice Department, we will continue working to streamline this process and to provide student loan borrowers a pathway to obtaining much-needed relief in bankruptcy.”
Why more borrowers are filing for bankruptcy
After over three years of forbearance, when borrowers were able to take a breather from their student loan repayments without accruing interest, millions of Americans were put back on the hook this fall.
Nearly 7 million of these borrowers are now in default, reports NPR, citing data provided by the Education Department. That figure has more than doubled over the past decade.
And while student loan delinquencies won’t be reported to credit bureaus until September of next year, this doesn’t hold true for other forms of debt that borrowers could be struggling to pay off as well.
With student loan payments resuming during a storm of high inflation and interest rates, the combined financial pressures could also lead to issues affording payments on other forms of credit, like cards and loans.
An analysis by TransUnion and the Boston Consulting Group found that as many as 1.4 million Americans could become seriously delinquent (when consumers are overdue on payments by at least 90 days) on at least one credit product within the next year due to student loan payments resuming.
The report also notes that 23% of survey respondents said they couldn’t resume student loan payments, which can amount to hundreds of dollars a month on top of other expenses, like rent, groceries, and gas.
An earlier study from TransUnion found the average student loan borrower deals with about $35,000 in debt, and one in five of these consumers could face monthly payments of over $500.
There can be severe consequences to your credit
With all these financial headwinds, it’s little surprise that some borrowers simply cannot afford making payments on their loans—and are turning to bankruptcy courts when they can’t get their debts forgiven.
For decades, student loan debt was treated differently than other forms of debt during bankruptcy filings due to concerns people would accumulate hefty loans during college and then try to erase them in court after they graduate.
But while filing for bankruptcy lets people walk away from their debts (or a portion of them), it comes with big implications for the long term.
Bankruptcy will remain on their credit report for between seven to ten years, and lenders, insurance companies, and even landlords check credit scores when they’re evaluating applications.
A declining credit score could mean higher interest rates tacked on to a future loan, or getting denied for that loan entirely.
Now that there’s an easier process for getting education debts discharged in court, it’s unlikely people burdened by student loans will file for bankruptcy unless they’ve exhausted all other options.
“Only borrowers who are facing extreme financial hardship seek to have their debt erased,” said higher education expert Mark Kantrowitz.
“The new policy represents a softening of the harsh stance on discharge of federal student loans,” he added.