A significant fraction of United States students relies on student loans to carter their high education level and other fees, including education and non-educational expenses such as living expenditures and books. According to a Forbes article, there are approximately 45 million borrowers indebted to nearly $1.6 trillion in student loans in the country (Friedman). Unfortunately, most students who take college loans end up with a debt they cannot repay, probably because of their unstable financial positions. As a result, some students choose to file for bankruptcy and try to discharge their loans, an exercise that has seen 40 percent of the students receive a hardship discharge (Iuliano 495). Although the current law allows students to claim their college loans in bankruptcy under exceptional circumstances, there remain heated policy debates on whether this exercise should prevail, notably in recent times when the student debt is a crisis and many Americans protest the loan repayment. In efforts to contribute to the ongoing discussion on the state of college loans in the United States, this research paper explores whether student loan debts should be undischarged in bankruptcy.
The question of whether student loan debt should be undischarged in bankruptcy can be evaluated from the lens of the merits and shortcomings of the practice, alongside existing empirical evidence on the policy. On the one hand, there are several benefits accrued with preventing the discharging of the college loans in bankruptcy, such as promoting the country’s economic growth. It is worth noting that some of the student loans are offered by commercial banks such as LendKey and PNC. Among the ways in which these banks profit is by charging an interest rate on their loans (Maigua and Gekara 121). Moreover, the bank’s performance is highly dependent on the loan default rate; arguably, a high risk of default may significantly affect a bank’s performance. Therefore, promoting a discharge of student loans in bankruptcy would adversely affect banks and ultimately the economy because of the high risk to their returns, considering that the loans are not guarded with any collateral.
Moreover, some scholars argue that restricting the discharge of student loans in bankruptcy is vital in preventing opportunist’s behavior and eliminating risks of moral hazards. According to Darolia, without restrictions to guard against moral hazard, student loans would be susceptible to fraud. Arguably, removing limitations governing student loans’ discharge would safeguard students against the consequences of default, increasing the default rate among borrowers.
However, empirical evidence nullifies these claims following an analysis of loan default rates before and after implementing the 2005 legislation that introduced private lenders’ protection. A study of millions of credit bureau records showed that bankruptcy behavior did not change significantly after introducing the policy (Darolia). Notably, scholars would expect a decrease in bankruptcy filings following the enforcement of the legislation. However, the research analysis revealed that the filings remain unchanged, implying that nondischargeability provisions may not reduce moral hazards and opportunistic behavior among borrowers. Arguably, opportunistic behaviors and moral hazards are not prevalent in the student loan market, explaining the lack of variation in bankruptcy filings after legislation’s implementation. Therefore, while some policymakers view undischarged student loans as a means to prevent opportunistic behaviour, empirical evidence shows that it may not have a considerable effect on these practices.
Furthermore, some supporters of nondischargeability of student loans in bankruptcy view it as an essential policy to ensure the loan programs’ longevity and prevent an increase in cost and interest of lending. Darolia notes that unlike other loans, borrowers of educational loans do not place collateral against the loans. The author also states that sometimes, student loans’ interest rates do not reflect their default risk, and neither are they risk-priced (Darolia). Therefore, in the event of a default, private lenders are likely to suffer substantial financial losses. Baker also avers that nondichargeability of the loans is a viable way of increasing the availability of student loans and decreasing their interest rates (1215). Arguably, while the government offers a majority of student loans, private banks also contribute significantly to the industry. It is worth noting that government loans are subsidized, and the default of such loans is recoverable through other government-enforced mechanisms. Conversely, default risks on private student loans may be a substantial financial blow to private lenders; therefore, without significant protection, such market players may be unwilling to offer college loans. Alternatively, private lenders may choose to charge higher interest on their loans that increase their loan prices.
However, the ripple effect of dischargeability on loan prices is highly contested. For example, Baker notes that there is considerable evidence that shows little to no impact on prices and loan availability following the modification of discharging student loans in bankruptcy (1215). This information suggests that while undischarged loans may protect private lenders from numerous default risks, they may have a minimum effect on loan availability and prices.
On the other hand, there are many benefits of discharging student loans in bankruptcy, such as relieving several debtors of the financial burden. Baker argues that modification of student loans is a viable way to allow overburdened debtors to pay their loans feasibly while obtaining a fresh start and fostering economic growth (1215). Baker’s argument is somewhat valid because of the existing evidence on the high number of graduates who cannot repay their loans because of financial constraints, medical complications, to mention but a few. Besides, some of the students who take the college students come from low-income families; thus, repaying the college loans and the interests would mean amplifying their poor economic status. Therefore, discharging the college loans would be an ideal way of relieving such students of the financial burden and enhancing their living standards. Besides, discharging the loans would enable students to start fresh and promote economic growth by directing their effort to generate money for household consumption.
As is evident from this research, scholars should analyze whether student loan debts should be undischarged in bankruptcy from both perspectives to determine a common ground that poses the least suffering to the parties involved. According to the synthesis of information in this paper, there are numerous shortcomings on students associated with nondischargeability of the loan debts, including the high financial burden placed on students who are already economically deprived. This study’s data also reveals that most arguments supporting nondischargeability of the debts lack empirical evidence, while some, such as preventing an increase in loan prices, are not applicable. With this information in mind, it is evident that student loan debts should be discharged because they would yield maximum benefits to the parties involved. However, effective measures should also be established to protect private lenders from default risks while also allowing students with valid reasons to file for bankruptcy.
Baker, Brendan. “Deeper Debt, Denial of Discharge: The Harsh Treatment of Student Loan Debt in Bankruptcy, Recent Developments, And Proposed Reforms.” Pennsylvania Journal of Business Law, vol.14, no. 2, 2012, pp.1213-1234.
Darolia, Rajeev. “Should Student Loans be Dischargeable in Bankruptcy?” Brookings, 29 Aug. 2015, www.brookings.edu/blog/brown-center-chalkboard/2015/09/29/should-student-loans-be-dischargeable-in-bankruptcy/. Accessed 14 Mar. 2021.
Friedman, Zack. “Student Loan Debt Statistics in 2020: A Record $1.6 Trillion.” Forbes, 3 Feb. 2020, www.forbes.com/sites/zackfriedman/2020/02/03/student-loan-debt-statistics/?sh=6f5af6ab281f. Accessed 14 Mar. 2021.
Iuliano, Jason. “An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard.” American Bankruptcy Law Journal, vol. 86, no.10, pp.495-526.
Maigua Cecilia, and Gekara Mouni. “Influence of Interest Rates Determinants on the Performance of Commercial Banks in Kenya.” International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 6, no. 2, 2016, pp.121-133.