Why Student Loans Are So Difficult To Discharge In Bankruptcy

Filing for bankruptcy has allowed millions of Americans to walk away from credit card debt, car loans, and even unpaid medical bills. But there there are two kinds of debt that are difficult to discharge in bankruptcy court: mortgages and student loans.

Congress has made it difficult to discharge mortgage and student loan debt in bankruptcy in part because of the widely shared belief that there are societal benefits to promoting home ownership and access to higher education. Home ownership helps Americans build wealth, and educated workers command higher salaries and are better able to compete in the global economy.

Tough restrictions on bankruptcy discharge are one of the factors that keeps investment capital flowing into home loans and student loans, which helps keep them available and affordable for many people.

When millions of Americans found themselves in foreclosure during the height of the mortgage crisis, lawmakers dismissed calls from consumer advocates that bankruptcy judges be allowed to “cram down” mortgage debt.

The lending industry successfully argued that changing the rules after the fact would spook investors in mortgage-backed securities, which is the source of funding for the vast majority of home loans.

Role of private lenders

While the government now funds about 90 percent of student loans directly, private lenders also make loans to borrowers with good credit, often at lower rates than government loans.

As a result, many graduates with strong prospects are refinancing pricey government loans with private lenders. Many of these loans are of such high quality that they can be bundled up and sold to investors, much like mortgages.