Damned by Default: Low-Income Borrowers and Student Debt

November 3, 2020 by Aburiyeba Amaso

by Andrew Harman

The United States faces a student debt crisis of epic proportions, as student loans are now the second largest household debt behind mortgages.[1] Perhaps more alarming than the sheer amount of student debt being accumulated by Americans is the rate of default on such debts, which is projected to reach as high as 40% by 2023 for borrowers who entered college in 2004.[2] Yet even if this doomsday scenario does not come to fruition, a whopping one million borrowers default on their federal student loans every year.[3]

Despite the narrative currently permeating societal discourse that the student default crisis is the result of irresponsible youngsters who over-borrow for useless degrees,[4] the facts paint a different picture. The vast majority of defaulters are older, more likely to be financially independent than other borrowers, and more likely to come from low-income families.[5] In fact, roughly 90% of defaulters have received a Pell Grant, and 40% fall in the bottom quartile of the income distribution.[6] Further, rather than borrowing excessively to finance degrees, the median defaulter owes just under $10,000.[7] In spite of these facts, leaders in government have been unable to develop a compelling solution to the issue of student loan default. While Congress is gridlocked on both small and sweeping issues related to student debt,[8] the Executive Branch has taken few steps to fix the issues that lead to default.[9] Meanwhile, the federal courts cannot even agree on a standard test that would allow for the discharge of student debt through bankruptcy.[10]

The economic impacts of default are not only severe for the individuals involved, who face huge hits to their credit scores, wage garnishment, and an inability to take out loans to complete their degrees, but also to the economy as a whole.[11] Defaulters are even less able to participate in the activities that drive the economy than their debt-saddled counterparts.[12] Their inability to buy homes, own and operate small businesses, and participate in meaningful retirement plans has negative repercussions for the American economy and is costing taxpayers money.[13] For example, in 2017, taxpayers spent $700 million to collect debts from roughly 7 million student-loan defaulters.[14] Yet for every $38 spent to recoup debts from defaulted accounts, just $1 was recovered.[15]

One of the most common proposals for helping low-income student loan defaulters lies in bankruptcy reform to make student debt more easily dischargeable. Unfortunately, because roughly 90% of those who default have received a Pell Grant, and the median obligation of student defaulters is less than $10,000,[16] bankruptcy is not a viable option for the cohort in question. Even if student debt was treated like any other consumer debt or unsecured loan, the cost of filing and the structure of bankruptcy proceedings would likely create a barrier to entry for indigent defaulters.[17] The average cost of filing for Chapter 7 bankruptcy ranges from $1,500 to $3,000, while a Chapter 13 bankruptcy ranges from $3,000 to $4,000 after filing fees, mandatory credit counseling, a financial management course, and attorneys’ fees.[18] These costs translate to roughly 15-40% of the median debt of 90% of defaulters. Additionally, with 40% of defaulters coming from the bottom quartile of the income distribution, bankruptcy poses a paradox where “the debtors who most likely would be able to show undue hardship cannot afford the litigation costs associated with bringing the action seeking discharge.”[19]

While defaulters could save on attorneys’ fees by filing pro se, success rates for pro se filers in run-of-the-mill bankruptcy cases are far from favorable. A 2007 sample of Chapter 7 filers who were represented by an attorney only had negative outcomes in 1.9% of proceedings; compare that with pro se filers, who experienced negative outcomes in 17.6% of proceedings.[20] Further, one would expect the more complicated bankruptcy proceedings involving student debt discharge to enjoy even lower success rates in pro se filings.[21]

One hurdle making filing for bankruptcy on student debt more complex is the requirement that a debtor seeking a discharge bring a separate adversary proceeding against the lender through a summons and complaint.[22] In these instances, the burden of proof falls on the debtor “to prove inability to maintain a particular standard of living…”[23] Law professor Anne E. Wells cites the case of Hedlund v. Educational Resources Institute, Inc. to highlight the importance of counsel in bankruptcy proceedings.[24] She notes that the debtor in this case only obtained the discharge of his student loans after “ten years, two bankruptcy court rulings, two district court rulings and two rulings of the Ninth Circuit for the matter to ultimately be decided.”[25] Even this outcome would have been highly improbable had the debtor not obtained the pro-bono services of a major law firm.[26]

Further, student loan debtors appear unwilling or unable to bear the cost of filing with such meager chances of success. Wells notes that The Wall Street Journal found there were only 713 adversarial proceedings to discharge student debt in 2014 compared to 36,488 adversary proceedings filed in all other bankruptcy cases.[27] Moreover, a separate study demonstrated that even when individuals with student debts filed for bankruptcy to alleviate their general debt burden, only 0.01% filed the necessary adversary proceedings to have their student loan debt discharged as part of their bankruptcy filing.[28] In the unlikely event Congress undertakes bankruptcy reform for the discharge of student debt in the near future, it will need to be so transformed as to make defaulters equally likely to file for discharge of their student loan debt as they would be for any other type of consumer debt. Until then, low-income defaulters are likely to be damned by default.


[1] Judith Scott-Clayton, The Looming Student Loan Default Crisis Is Worse Than We Thought, Brookings Inst., (Jan. 11, 2018), https://www.brookings.edu/research/the-looming-student-loan-default-crisis-is-worse-than-we-thought/.

[2] Id.

[3] Kristin Blagg, Underwater on Student Debt: Understanding Consumer Credit and Student Loan Default, Urban Inst. (Aug. 2018), https://www.urban.org/sites/default/files/publication/98884/underwater_on_student_debt_0.pdf.

[4] Nick Phillips, A Conservative Response to the Student Debt Crisis, The American Conservative (Nov. 27, 2017), https://www.theamericanconservative.com/articles/a-conservative-response-to-the-student-debt-crisis/comment-page-1/.

[5] Ben Miller, Who Are Student Loan Defaulters?, Ctr. For Am. Progress (Dec. 14, 2017), https://cdn.americanprogress.org/content/uploads/2017/12/11044919/StudentLoanDefault-brief1.pdf.

[6] Id. at 5.

[7] Id. at 6.

[8] See S. 2993, 113th Cong. (2014) (showing that Sen. Murphy (D-Ct.) introduced a bill aimed at holding for-profit schools and their executives accountable for violations and poor performance, which did not make it out of the Senate); S. 2272, 114th Cong. (2015) (demonstrating that Sen. Durbin (D-Ill.) introduced a bill to close a loophole used by for-profit colleges to avoid the so-called 90/10 rule by collecting off of the GI bill and other military assistance programs, but it failed to receive a vote in the Senate); See also Lauren Camera, Behind the scenes, Congress is making progress on revamping the Higher Education Act, U.S. News and World Report (Feb. 9, 2018), https://www.usnews.com/news/the-report/articles/2018-02-09/congress-makes-quiet-progress-on-higher-education (showing partisan gridlock has hindered reform of for-profit universities for years, and despite bipartisan progress on other aspects of major education reform, many proposals serve as non-starters for Democrats – including the elimination of protections for student loan borrowers from for-profit colleges).

[9] Jason D. Delisle and Lexi West, Student Loan Servicers: Scammers or Scapegoats?, Am. Enter. Inst. (2019), https://www.aei.org/wp-content/uploads/2019/10/Student-Loan-Servicers.pdf; but see Kevin Carey, It’s Easy to Forget, but a Program to Forgive Student Loans Already Exists, N.Y. Times (July 24, 2019), https://www.nytimes.com/2019/07/24/upshot/student-debt-forgiveness-already-happening.html (demonstrating that President Obama successfully directed the Department of Education to expand repayment options to ease the burden of student loans on debtors); Michael Stratford, Trump Eases Student Loan Forgiveness For Disabled Veterans, Politico (Aug. 21, 2019), https://www.politico.com/story/2019/08/21/trump-student-loan-veterans-1675170 (showing that President Trump canceled the student loan debt of roughly 25,000 disabled veterans).

[10] Ben Wallen, One Standard to Rule Them All: An Argument for Consistency in Education Debt Discharge in Bankruptcy Proceedings, 16 Hous. Bus. & Tax L. J. 232, 233 (2016) (with notes 69 and 70 highlighting the multitude of divergent approaches courts take in bankruptcy proceedings on student debt).

[11] Phillips, supra note 4; see infra notes 22-24.

[12] Phillips, supra note 4.

[13] Brent W. Ambrose, Et Al., Working Paper No. 15-26: The Impact of Student Loan Debt on Small Business Formation, The Fed. Reserve Bank of Phila. (2015), https://www.philadelphiafed.org/-/media/research-and-data/publications/working-papers/2015/wp15-26.pdf; U.S. Gov’t Accountability Office, GAO-17-22, Report to the Chairman, Committee on the Budget, U.S. Senate: Federal Student Loans: Education Needs To Improve Its Income-Driven Repayment Plan Budget Options (Nov. 2016), available at: https://www.gao.gov/assets/690/681064.pdf.; Matthew S. Rutledge, et al., Do Young Adults With Student Debt Save Less For Retirement?, Ctr. For Ret. Rsch. at Boston Coll. (2018), https://crr.bc.edu/briefs/do-young-adults-with-student-debt-save-less-for-retirement/; Fed. Reserve, 1 Consumer & Community Context (Jan. 2019), https://www.federalreserve.gov/publications/files/consumer-community-context-201901.pdf?mod=article_inline.

[14] Shahien Nasiripour, Americans Are Paying $38 to Collect $1 of Student Debt, Bloomberg (May 19, 2017), https://www.bloomberg.com/news/articles/2017-05-19/americans-are-paying-38-to-collect-1-of-student-debt.

[15] Id; see also Consumer Fin. Prot. Bureau, Update from the CFPB Student Loan Ombudsman: Transitioning from default to an income-driven repayment plan (May 26, 2017), https://files.consumerfinance.gov/f/documents/201705_cfpb_Update-from-Student-Loan-Ombudsman-on-Redefaults.pdf.

[16] Miller, supra note 5, at 6.

[17] Anne E. Wells, Replacing Undue Hardship with Good Faith: An Alternative Proposal for Discharging Student Loans in Bankruptcy, 33 Cal. Bankr. J. 313, 317 (2016).

[18] John O’Connor, How Much Does it Cost to File Bankruptcy? National Bankruptcy Forum (Dec. 7, 2017), https://www.natlbankruptcy.com/how-much-does-it-cost-to-file-bankruptcy-2/.

[19] Wells, supra note 17, at 332.

[20] Angela K. Littwin, The Affordability Paradox: How Consumer Bankruptcy’s Greatest Weakness May Account for Its Surprising Success, 52 Wm. & Mary L. Rev. 1933, 1973 tbl.3a (2011).

[21] Wells, supra note 17, at 332.

[22] Id. at 326.

[23] John Patrick Hunt, Help or Hardship?: Income-Driven Repayment in Student-Loan Bankruptcies, 106 Geo. L.J. 1287, 1334 (2018).

[24] Wells, supra note 17, at 332.

[25] Id.

[26] Id.

[27] Id. at 331.

[28] Jason Iuliano, An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard, 86 Am. Bankr. L.J. 495, 505 (2012).