You may soon be able to declare bankruptcy on your student loans—here's how

It may soon be easier to declare bankruptcy on your student loans

Student loan borrowers in the United States collectively owe almost $1.5 trillion in student debt, and according to the Brookings Institute, almost 40 percent of borrowers will default on their student loans by 2023.

Currently, it is nearly impossible to have your student debt forgiven during bankruptcy — but that may soon change. In February, the Department of Education announced that it will review and potentially alter policies that make it difficult for student debt to be discharged in bankruptcy.

Miranda Marquit, personal finance expert at Student Loan Hero tells CNBC Make It that there are three steps for discharging student debt in bankruptcy: Borrowers must find a lawyer, decide what type of bankruptcy proceeding to pursue and prove that they face "undue hardship."

"It's almost impossible to discharge student loans in bankruptcy," Student loan expert Mark Kantrowitz tells CNBC. "The problem was undue hardship was never defined, and the case law has never led to a standardized definition."

What happens when you don't pay off your debt?

Without a clear picture of what's implied by undue hardship, courts often use an evaluation process known as the "Brunner Test."

"Basically, you have to show that you can't maintain a basic standard of living while paying the student loans and that this difficulty would last throughout a large chunk of your repayment period," explains Marguit. "Plus, you have to prove that you tried to repay the federal loans."

Now, the Department of Education is exploring how to explicitly define undue hardship. Clare McCann, deputy director of higher education policy at think tank New America and a former Education Department official tells Inside Higher Ed that the Department of Education's latest actions indicate that they will broaden the phrase's definition.

Democrats have previously advocated for a clearer and broader definition, suggesting that specific criteria such as eligibility to receive social security or having a military service-related disability be used in order to determine if a borrower is truly unable to pay their loans.

Making it easier for students to discharge student debt could streamline the bankruptcy process and would help borrowers in serious trouble begin to rebuild their lives.

In recent congressional testimony, Jerome Powell, new Chair of the Federal Reserve said that the student debt crisis has the potential to hinder the economy and that current student loan bankruptcy policies did not make economic sense.

"It absolutely could hold back growth," said Powell, as reported by Market Watch. "You do stand to see longer-term negative effects on people who can't pay off their student loans. It hurts their credit rating. It impacts the entire half of their economic life."

"Alone among all kinds of debt, we don't allow student loan debt to be discharged in bankruptcy," he said. "I'd be at a loss to explain why that should be the case."

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