Bankruptcy & Student Loans

    student loan bankruptcyMore than four million borrowers have defaulted on student loans, but if they’re hoping bankruptcy will bail them out, they better have a Plan B.

    The majority of consumer debt – things like homes, cars, medical bills, etc. – can be discharged in bankruptcy, meaning the court wipes out the debt and the lenders can’t take any legal action to collect.

    However, student loans are among a handful of debts (child support, alimony, tax obligations, fines and fraudulent debt) that can’t be discharged, except in very rare instances.

    How rare? Filing bankruptcy on a student loan is practically like buying a lottery ticket.

    “If student loan debt is the main reason you’re filing for bankruptcy, your lawyer should tell you not to expect it will be discharged,” said Dan Austin, author of “Student Loan Debt in Bankruptcy: An Empirical Assessment.”

    “That’s the premise people should have when they start the process. There are a lot of difficult hurdles to overcome, but they should be aware that there are some exceptional situations where people have had success.”

    Austin, a bankruptcy attorney in Erie, Pa., said those exceptional cases usually are based on one of three conditions:
    • Severe and readily documented medical problems. The debtor must establish that they are physically and mentally incapable of earning an income that would sustain payments for student loans. There would have to be testimony from reputable medical providers to substantiate the claim.
    • Extreme economic circumstances. If a borrower had a large student loan debt and tried to repay it for 10-15 years, but had problems finding full-time work that would allow them to keep up payments, that might resonate with a judge.
    • Age issues. If a borrower has reached retirement age and still has a huge amount of student loan debt – more than $100,000, Austin said – that might get empathy from a judge.

    “Historically, the best-case scenario for having student loan debt discharged in bankruptcy is having a severe medical condition,” Ausin said. “A much smaller minority of people succeed with the economic and age arguments.

    “If people want to pursue it, there is a chance they can succeed, but there really should be no expectation it will be discharged.”

    Defaulting on Student Loans

    How many parents have student loans?

    The Department of Education said that 3.3 million borrowers had $74.5 billion in Parent Plus loans in 2016 to pay for their children’s education. Another study by the University of Southern California said the average parent borrows $21,000, but that parents with incomes higher than $120,000 borrow an average of $30,000.
    The Consumer Financial Protection bureau said that 2.8 million people 60-and-over were paying on student loans in 2017. That is four times the number who borrowed in 2007. Even worse, the Government Accounting Office says that 37% of student loan borrowers age-65 and over are in default.

    If you’re considering bankruptcy, your loans are probably already in default, meaning you haven’t made a payment in more than 270 days (nine months). This is more common than you may think. The national default level on student loan repayment is approximately 10%, meaning that 4.4 million borrowers are in default on America’s $1.4 trillion student loan problem.

    The Department of Education said that the default rate was falling in 2016, but that is misleading according to many experts because nearly 6.5 million borrowers were in deferment or forbearance, two forms of delay before a borrower goes into default.  Austin said his research indicates that 40% of student loan borrowers are either delinquent (90 days past due on payments) or in default (270 days past due).

    If You Ignore Your Debts

    Ignoring your student loan debts is the worst option. Once you’re in default on government-held loans – which accounted for 90% of all student loans in the 2016-2017 school year – the federal government has extraordinary collection powers. It can garnish wages, seize tax refunds or portions of Social Security benefits, and place liens on bank accounts and property.

    And unlike other types of debt, there is no statute of limitations on federal student loans.  That means that a student loan debtor can be hounded to the grave by the federal bureaucracy or the agency that services loans on behalf of the Department of Education.

    Also, after a stipulated number of months of non-payment, a loan can be transferred to a private collection agency. Additional fees and collection costs are then added to the loan balance.

    Rather than trying to ignore your student debt problem, it’s best to take action as soon as possible, even if that means going into bankruptcy.

    Process for Discharging Student Loans

    Student loan bankruptcy is usually part of a Chapter 7 or Chapter 13 bankruptcy filing. The Chapter 7 bankruptcy is an attempt to have all unsecured debt discharged. The Chapter 13 bankruptcy is an attempt to have the debt reorganized in payments the borrower can afford.

    Student loan bankruptcy laws are tilted heavily in favor of the lender. There are strict guidelines as to whether your student loans can be erased and they apply to any loan specifically granted for education expenses, including both private and public student loans. They apply to student borrowers as well as parents borrowing loans to pay for their children’s education.

    If you want to pursue bankruptcy for you student loan debt, the first step would be to find a a reputable bankruptcy attorney. One of the reasons so few student loan bankruptcy cases are successful is because more than 50% are filed by the borrower, who has no legal training or understanding of the court system. According to Austin, probably another 40% or more are pro bono cases, meaning the lawyer is donating his time for free.

    Either way, the odds are stacked against the borrower right from the start.

    To succeed, you must be able to prove that your student loans “impose an undue hardship on you and your dependents.” The term “undue hardship” has endless interpretations, but most of them have favored creditors.

    When you get to court, you will have to go through what is known as an “adversary proceeding” which is a court case within a court case and another reason to hire a lawyer. At the adversary proceeding, which focuses solely on the student loan part of your bankruptcy filing, you must convince the judge of your hardships, which cumulatively are known as the “Brunner Test.”

    The Brunner test is three standards drawn from a 1987 court case (Brunner v. New York State Higher Education) that set the standard for how much proof the debtor must bring to have a student loan debt discharged.

    Courts use three criteria for verifying undue hardship:
    • You are unable to repay your student loans while also maintaining a minimal standard of living for yourself and any dependents. This takes into account your current income, your typical expenses, the U.S. poverty level and your minimum monthly payments.
    • Your hardship is likely to continue for all or most of your repayment period, and you are unable to change your circumstances. This so-called “certainty of hopelessness” is typically only applicable if you or a dependent has a permanent disability. You may also qualify because of a serious physical or mental illness.
    • You have made legitimate efforts to repay your loans for at least five years and have tried other options such as an extended repayment plan. The exception to this is if you become disabled or have other extenuating circumstances before five years have passed.

    These three criteria are fairly subjective and are open to interpretation by the bankruptcy court judge. Each court can have its own variations as to what constitutes undue hardship.

    The request to get rid of student loans is usually made at the conclusion of bankruptcy proceedings.

    Likelihood of Discharging Student Loans

    Why Is It So Difficult To Discharge Student Loans?

    In 1976, Congress prohibited federally guaranteed student loans from being discharged in bankruptcy except under conditions of undue hardship. This was in response to largely unfounded fears of too many student debtors looking for an easy way out of their obligations.

    This put student loan debt in the same category as financial obligations like child support, alimony and criminal fines.

    In 2005, Congress added private student loans to the list of debts that cannot be discharged.

    In most bankruptcy cases, consumers don’t even attempt to have student loans discharged. Instead, their lawyers focus on other issues such as credit card debt.

    Austin said that less than 1% of bankruptcy filings include student loans, even when there is a compelling case. He cited a situation in which a single mother on a teacher’s salary and battling cancer didn’t bother filing for bankruptcy, despite more than $150,000 in student loan debt.

    However, in most cases, the legal hurdles that have to be overcome are so daunting that most lawyers advise their clients not to include student loan debt in their bankruptcy filing. Also, there are now several income-driven repayment plans such as Pay As Your Earn (PAYE), Repay As You Earn (REPAYE), Income Contingent Repayment (ICR) and Income Based Repayment (IBR) that most borrowers should be able to find a program they can afford.

    Surprisingly, about 40% of the cases that are filed, actually are successful.

    Some evidence shows that privately held student loans are more likely to be discharged, though it’s still rare. It’s estimated that of private student loan holders filing for bankruptcy, less than 1 percent seek to clear these loans. Of those who do, less than half are successful.

    When Bankruptcy Doesn’t Discharge Student Loans

    Even if bankruptcy cannot discharge your student loans, it may still be the right option for you.

    People struggling with student loan debt often have additional outstanding debts ranging from credit card debt to unpaid mortgages. Bankruptcy can discharge these other debts, freeing up more funds to pay down your student loans.

    Still, it’s wise to avoid bankruptcy whenever possible. Consider student loan consolidation as a way to simplify education loans, and try using debt settlement to minimize other types of debt.

    If you borrow money, you have a moral and legal obligation to pay that money back. Students and parents should take the time to do cost-benefit analysis and long-range planning before accepting student debt of any amount.

    But remember that bankruptcy laws were written to give people a second chance. If your debt load is overwhelming and you don’t see a reasonable way out, bankruptcy is a legitimate debt-relief option. Even if you don’t meet the criteria for student loan discharge, it might be possible to discharge other debts, freeing up resources to allow you to pay the student loans.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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