The national student debt is now at $1.6 trillion. Students loans are currently the second largest slice of household debt after mortgages. In 2019, about one in eight Americans had student loan obligations.
Many financial models predict that 40 percent of all federally backed student loans will be defaulted by 2023. Defaulting on a student loan obligation can create a snowballing crisis for borrowers including fees from loan servicers, a damaged credit score, and eventually the garnishment of wages or government benefits.
In some states, people can lose their professional licenses or driver’s licenses as a result of defaulted student loans. Moreover, impending student loan defaults will affect all Americans, because the government will not be able to realize $560 billion in student loan repayment that it already accounted for.
Bankruptcy is meant to give borrowers who are truly unable to repay their financial obligations, a fresh start. However, a borrower cannot discharge federally backed student loans through normal channels. The discharge of student loans is governed by the “undue hardship” standard of Section 523(a)(8) of the Bankruptcy code.
In enacting the “undue hardship” standard, Congress was primarily concerned about abusive student borrowers and protecting the solvency of student loan programs. Based on pertinent legislative history and the actual text of the act, it is clear that Congress had little to say on the dischargeability of student loans.
Thus, the task of defining what constitutes an “undue hardship” in the student loan context fell upon the federal judiciary. The federal judiciary found that for a borrower to meet the “undue hardship” standard, they must prove that if they are forced to repay their student loans, they will be unable to maintain a “minimum standard of living.”
Federal courts disagree on how to determine if a borrower can maintain a “minimum standard of living.” Some federal courts apply a bright-line rule that only considers whether the borrower’s income is greater than their expenses. A federal court in Pennsylvania found that, absent bright lines, a borrower maintains a “minimum standard of living” when their lifestyle is somewhere between a lifestyle subjected to poverty and a life of mere difficulty.
A federal court in Illinois did not discharge a borrower’s student loans because it found that the borrower was able to maintain a “minimum standard of living.” In that case, the borrower sought to discharge a commercial truck diving school loan of $7,874, with monthly loan payments of either $100 or $163 depending on the loan’s repayment period.
The borrower. along with his dependent and wife, lived in a rented mobile home. The borrower, his spouse, and dependent did not have health insurance. The borrower’s finances showed that he had $176 in monthly discretionary income. The court found that the borrower “had the present ability to reasonably make loan payments” because his monthly discretionary income would be at the least, $13 greater than their monthly loan payments.
The “minimum standard of living” requirement, in a vacuum seems reasonable because it ensures that borrowers who can repay their student loan obligations do so. However, the “minimum standard of living” requirement for student loan discharge is unrealistic because it forces low-income borrowers who live paycheck-to -paycheck to pledge their meager discretionary income for the repayment of their student loan obligations. Moreover, due to their limited discretionary income, any unexpected expense like a flat tire, could render a low- income borrower unable to meet their monthly loan payments, which can have a snowballing affect for a low- income borrower.
Instead of blindly applying the “minimum standard of living” requirement, it would be in society’s best interest for Congress to modify the requirement for low-income borrowers.
First, Congress should find that a borrower cannot maintain a “minimum standard of living” requirement if their lifestyle does not include necessities such as: a clean shelter; basic utilities like electricity and heating; necessary house appliances like a refrigerator and stove; adequately maintained vehicles; health insurance for every member of the borrower’s household; life insurance created by the borrower for their dependents; and some form of recreation for the borrower and their dependents.
Second, Congress should determine a low-income borrower’s income only after excluding the portion of the borrower’s income spent on allowable living expenses, set out by the IRS, and the amount of the borrower’s income supplemented by government assistance. Discretionary income, which does not include allowable living expenses and government assistance, will present an accurate amount of money that the borrower could reasonably spend to repay their student loan obligations.
The “minimal standard of living” requirement threatens the financial health of individual borrowers and our entire society. Without common sense reform, the negative externalities from student loan defaults will be impossible to mitigate.