Category Archives: Student Loans

Discharging Student Loans - The Unicorn of the Bankruptcy World

By Jeff Curl, San Mateo Bankruptcy Attorney

A colleague of mine attended a student loan webinar put on by collection companies that chase down student loan borrowers in default. He asked for an estimate of the percentage of student loans facing a discharge in bankruptcy court. In other words, How often do bankruptcy courts grant discharges of student loans?

The presenter’s response was that discharging student loans was the unicorn of the bankruptcy world.

Student loan lenders and the collection companies do not fear borrowers that declare bankruptcy because student loans are not dischargeable unless the borrower can show an “undue hardship.”

Proving an “undue hardship” first requires a debtor in bankruptcy to file an adversary proceeding to discharge student loans. An adversary proceeding is a lawsuit by the debtor/borrower against the lender.

This in itself is a barrier to entry that eliminates most borrowers from pursuing discharging student loans. The expense of pursuing a lawsuit is cost prohibitive. If you filed bankruptcy with large student loan debts in the first place, funding litigation against a bank or collection company is just not in the cards for most people.

Second, the burden on the debtor/borrower to prove that the student loan is an undue hardship is very difficult. There have been some cracks in this high burden, but the courts where we practice still are bound to follow a very strict standard.

This is not to say that there are not appropriate cases where an undue hardship exists. But when collection companies openly declare discharging student loans as the unicorn of the bankruptcy world, expect resistance and be prepared for a fight.

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Can Bankruptcy Discharge My Student Loans?

The Student Loan Debt Crisis

It seems that no matter what angle we view student loans from these days, the picture never looks pretty. This blog from Consumer Finance Protection Bureau documents how there are 27.8 million student loan borrowers making use of the direct federal lending program totaling more than $1 trillion in debt. Only 10.8 million of these borrowers are currently repaying these loans. That is, only 38.8% of the borrowers are in repayment. That does not mean the other 61.2% are in default; actually 2.1 million people or 7.6% of borrowers are in default.

Other borrowers are in some sort of suspense mode: 5 million borrowers (18%) are in deferment or forbearance. 7.9 million borrowers (28.4%) are still in school. And 1.9 million (7.2%) are in a six month grace period given to borrowers after graduation.

I see a lot of clients that owe $50,000, $100,000 and sometimes in excess of $250,000 that are hoping to discharge these loans in bankruptcy. I hardly blame them for seeking shelter given the powers granted to the government as the lender of student loans. First, there is no statute of limitations, meaning the loan stays with you for life. Second, the Direct Loan servicing program can intercept your tax refund if you default. Third, the Direct Loan program can garnish your wages without a court order if you default on your student loans.

Bankruptcy offers limited solutions. It is possible to buy time or even discharge student loans in bankruptcy. But an actual discharge of these loans is far different from something like a credit card. In Chapter 7 bankruptcy, a typical credit card debt is listed in the bankruptcy filing and discharged by operation of law if the person filing bankruptcy complies with all requirements such as attending the meeting of creditor and taking the post filing debtor education course.

Student loans are different. The person filing bankruptcy must file an adversary proceeding against the student loan lender. This is essentially a lawsuit which can take a lot of time and expense. If student loan borrowers could afford to pay an attorney to litigate a student loan debt all the way to trial in bankruptcy court, chances are the client could pay the student loan in the first place. And the courts have set standard for discharge so high, it adds another incentive to avoid filing such an action. Discharging student loans through this route is therefore often just an illusion.

So federal student loans are standing at over $1 trillion. Add private loans, we reach $1.2 trillion. Anyone else sense a bubble? As the great economist — okay, I really mean Barry Gibb from the Bee Gees — stated: “[A]ll bubbles have a way of bursting or being deflated in the end.” Congress needs to reform the loan forgiveness for federal loans, and/or revise the bankruptcy code to make student loans dischargeable to some extent.

I’d rather manage a slowly deflating balloon than go for the ride we took in 2008 and 2009 with a full burst.

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Podcast #8 - Ways to handle overwhelming student loans

San Francisco bankruptcy lawyers Jeena Cho and Jeff Curl are seeing more clients with unmanageable student loan debt. Jeff and Jeena rant about the state of student loans, and then discuss solutions both in Chapter 7, Chapter 13 bankruptcy and outside of bankruptcy.

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I can’t pay my student loan debt. Can bankruptcy help?

 

According to a recent article in US Today, student loans will exceed $1 trillion this year. Unlike most other unsecured debts, student loans have a special status in bankruptcy in that it cannot be discharged (forgiven) through bankruptcy.

I meet with a lot of clients who have a ton of student loans and struggling to make the monthly payments. So, what can be done with student loans? Here are a few options to consider.

1. Go back to school

I know this may sound counterintuitive. After all, the last thing you probably want to do is go back to school after having just graduated. But, by going back to school, you may be able to put your student loans into deferment. Generally, you must take 6 or more credits. Community colleges are very inexpensive and you can take 1 credit for around $40. For example, San Mateo Community College will run you $354 for 6 credits including fees and parking.

Be sure to check with your student loan on this. Some private loans cannot be deferred even if you return to school.

2. Contact student loan for different repayment option

This one is obvious but worth mentioning. Most student loans have various repayment options designed to fit your income. Call your student loan company and ask.

3. File Chapter 13

While bankruptcy can’t get rid of your student loan debt, Chapter 13 can keep the student loan company at bay for 5 years at a time. This is how it works. Once your Chapter 13 is filed, an Automatic Stay goes into effect, which prohibits further collection activities - including student loan debt.

In Chapter 13, your monthly payment is determined by your “disposable income” which is calculated by taking your income minus your expenses. This is the amount you are required to pay on a monthly basis in Chapter 13. So, by filing Chapter 13, you can keep the payments at a level you can afford.

Here’s the catch though. This may actually lead to an increase in the amount you owe because if you pay less than the actual monthly minimum payments, the difference will be recapitalized.

The idea is that at the end of the 5 year period, you’ll be in a better financial position to be able to repay the student loan. Chapter 13 is also ideal if you have other debts such as credit cards and personal loan, which will be discharged at the end of Chapter 13.

None of these solutions are perfect but there are options out there for dealing with student loan debt.

 

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Political Hostage

“Politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other.” Oscar Ameringer

Bankruptcy is a political creature in its origin. The right to create bankruptcy laws is written in the United States Constitution. Congress over time has made use of this right, and enacted bankruptcy laws known as statutes that govern bankruptcy rules and procedures. The last big overhaul was in 2005, known as the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). The banking and creditor industry lobbied for years to pass this legislation. And several years after its passage, most people are still looking for the “Consumer Protection” part of the statute.

Since bankruptcy laws are borne in our political sausage making machine, the laws’ creation and changes are dependent on the mood of the country, the strength of the lobbyists, who’s in Congress and who’s the president, among a myriad of other factors. For as long as I can recall, every year it seems it is declared that politics is getting worse. I don’t know if this actually true, or if it just feels like it.

But I do sense a lot of desperation and rage. The Tea Party coalesced around a message against a big government that helped create a massive debt problem. Occupy Wall Street seems to be gaining traction with a message about the majority feeling disenfranchised by an increasing wealth gap created and sustained in part by a corrupt corporate/capitalist relationship. Someone sent me this Venn diagram about the two movements:

The point is that whatever the underlying belief is about the current cause of our problems as a nation, a lot of people are tired and angry. This feels like a recipe for change. Whether it’s a good recipe, that remains to be seen.

A lot of people need help. And bankruptcy is one way to help people in financial distress. My hope is that this turmoil creates the political will and landscape to rectify some of the mistakes in the bankruptcy code. Two examples:

  • Debt Limits in Chapter 13. Congress set the maximum amount of debt that a person can have in Chapter 13; you can have $360,475 in unsecured debt, and $1,081,400 in secured debt. These limits apply across the nation. This makes no sense as a national number. Don’t you think the mortgages in the Bay Area might be a little different than Mississippi? If you have mortgages or liens that exceed this number, you’re looking at Chapter 7 or 11 only. A lot of people that should be in Chapter 13 are left out by this senseless restriction. The irony is that many of the changes brought by BAPCPA were intended to funnel more people from 7 into 13. Well done, Congress, well done.
  • Student Loans. These are not usually dischargeable in any chapter of bankruptcy. Congress decided certain things were important and as a policy not dischargeable, such as child support and alimony. Okay, fine. But alimony and child support were given a special status. In Chapter 13 creditors are assigned priorities on how they are repaid. For example, child support arrears are a high priority debt, and your typical credit cards are low priority. This means that if you file a Chapter 13 and repay some of your debt, the money would first go to the child support arrears before the credit cards ever see a dime, if they see any money at all. Congress decided child support is both nondischargeable, and should be given a higher priority so that it is paid off.

Student loans are also nondischargeable, but were not given an explicit high priority status. They are treated like a last in line creditor. This means that at the end of a Chapter 13, depending on the arrangement of your debts, you may actually owe more to your student than when you started because they never received any of the money as a low priority creditor, so interest and penalties continued to accrue. This is one of the worst rules I keep running into. It only gets worse as student loan debts have swelled to record highs.

Is the current national mood willing and able to foster changes to the bankruptcy code? I hope so. I don’t believe in writing a bankruptcy code that is so loose that people “get away” with misdeeds through bankruptcy. But I also believe in fairness and correcting poorly or unfairly drafted legislation. The current code is riddled with errors that need legislative attention, particularly now as more and more of our clients hang on the downward sliding precipice of middle class status.

Images courtesy of James Sinclair and Schteeve2010.