Bankruptcy & Student Loans

    While student loans can help you earn a degree and increase your overall wealth, they can also be crippling to your finances. High monthly payments, especially for new graduates still looking for work, can become overwhelming almost immediately. In fact, a survey of recent graduates showed that a fourth had gone lengths of time without paying their loans.

    For such graduates, bankruptcy may seem like the only way out of an increasing mound of debt. But the truth is bankruptcy almost never gets rid of student loans. Current laws require that people with student loans continue making their payments even if they go bankrupt.

    Still, it is not completely impossible to get rid of student loans through bankruptcy. Though the process is lengthy and difficult, it can help relieve your debt when you are in the direst of situations.

    Defaulting on Student Loans

    How many parents have student loans?

    Of parents whose children graduated in 2010, an estimated 17 percent took out student loans. In fact, parents account for roughly 10 percent of the $1 trillion in outstanding student debt.

    Parents who take out student loans carry an average of $34,000 in student debt, a figure that rises to about $50,000 over a standard 10-year repayment period.

    If you’re considering bankruptcy, your loans are probably already in default, meaning you’ve missed nine or more consecutive payments. This is more common than you may think; the national default level on student loan repayment is approximately 9 percent.

    The Institute for Higher Education Policy recently examined default rates by studying Class of 2005 graduates after five years. It also looked at delinquencies, which occur after just one missed payment.

    Of borrowers who began repayments the year they graduated, 25 percent became delinquent at some point and an additional 15 percent had defaulted. Only 40 percent of borrowers had made on-time payments as agreed.

    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 percent of all student loans in the 2010-11 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.

    Discharging Student Loans

    There are strict guidelines as to whether your student loans can be erased through bankruptcy. 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 have student loans discharged through a personal bankruptcy filing, you must be able to prove that your student loans cause you “undue hardship.”

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

    A 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, lawyers don’t even attempt to have student loans discharged. Instead, they focus on their clients’ other debts such as credit card debt.

    The Educational Credit Management Corporation, an agency specializing in federal student loans of bankrupt borrowers, reported its experience in 2009. Of 72,000 borrowers filing for bankruptcy, only 276, or 0.4 percent, sought to have their student loans discharged. Less than a quarter of these had their education debts fully or partially erased.

    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.

    Cecillia Barr

    Cecillia Barr is a graduate of the University of Central Florida. She blogs about her extensive knowledge on student loans in order to help others reduce their debt and live financially independent lives.

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