Can My Student Loan Debt Be Discharged in Bankruptcy?

Can My Student Loan Debt Be Discharged in Bankruptcy

The short answer is usually no for federal loans. Let’s explore why and the possible exception.

In a case from 2012, a married couple who was filing for bankruptcy tried to get their student loans forgiven. They argued that the loans were not “educational loans” under the chapter 13 bankruptcy statute, and repaying the loans would cause “undue hardship” if the loans were not discharged in the bankruptcy. Between the husband and wife, there were eleven different creditors with a combined total of $456,221 in unsecured student loans. Each of them had over $100,000 in individual loans, and nearly $200,000 in joint loan debt.

The husband was 29 years old and had a bachelor’s degree in business administration, and the wife was 27 years old with a bachelor’s degree in business. Their combined annual salary was just over $100,000 in 2011.

Under the federal bankruptcy statute, educational loan debt cannot be discharged in the bankruptcy.

Educational loan debt that cannot be discharged in a bankruptcy breaks down into four categories:

Loans made, insured, or guaranteed by a governmental unit

  • Loans made under any program partially or fully funded by a governmental unit or nonprofit
  • Loans received as an educational benefit, scholarship or stipend
  • Any “qualified educational loan” as defined by in the Internal Revenue Code(IRC)
    • Basically, the IRC defines this as any indebtedness incurred by the taxpayer solely to pay for higher education expenses, or the “cost of attendance” at an eligible educational institution, as defined under Title IV of the Higher Education Act of 1965
      • The cost of attendance includes tuition, books, room and board, etc.

The husband and wife debtors in this case only had to assert that their creditors had failed to prove that the loans fell into one of these four categories, because the burden of proof is on the creditors, since they have access to all the information regarding the debt. The creditors invoked the fourth category, which in itself is broad. Even though the debtors had attended numerous different schools during their undergraduate education, all of those schools were Title IV eligible.

Although the couple tried to argue that the creditors had to prove that the loans were used to pay for the cost of attendance, the court held that what mattered was the stated purpose of the loans when they were received, not how they were actually spent.

There is an exception to the statute if requiring repayment of the loans would create undue hardship.

The statute does not define undue hardship, so the question is usually on for the judge or jury, as a factual question, not a question of law. The court in this case considered three factors to determine if there was undue hardship.

Three factor test of undue hardship from forced repayment of student loans:

  • Unable to maintain a “minimal” standard of living for themselves and their dependents
  • Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period
  • Good faith effort to repay the loans

All three of these factors must exist to satisfy the test and for the loans to be discharged, and any other extraneous concerns are not considered. This standard is high and difficult to meet. There is some debate as to whether part of a loan debt could be discharged to the extent that is did meet the test, while the rest of the debt would remain.

In this case, the husband and wife failed to meet any of the factors in the eyes of the court. The only cases that have satisfied the test are situations where the total income is around the poverty line. The situation must be beyond reasonable control, and the debtor must somehow prove that they will be unable to pay their student loan in the future, for the period of repayment, which is usually a long time. Also, maintaining a minimum standard of living does not include owning a car, or having a large house. Minimum means minimum. In this case, even a monthly loan payment of over $4000 a month was not excessive, although it would require the husband and wife to reduce their monthly expensive otherwise.

What if I Ignore My Student Loans?

Ignoring student loan debt will not make it go away. If you’re not in the extreme situation that would allow the loans to be discharged in bankruptcy, then not paying the loans will first cause you to default. Most federal loans are in default after you have not paid for 270 days. Your credit score will suffer and the interest will continue to pile up.

A private creditor could sue for continued non-payment, and if you lose then a judgment will be entered against you for the amount owed. This judgment means that the creditor can collect using any power the state grants, which may include garnishing your wages. The federal government on the other hand can intercept tax returns and garnish up to 15 percent of your wages without suing.

Some states such as Texas do not allow your wages to be garnished for private creditors, but the federal government can still garnish if the loan is in default.

There are other ways to relieve student debt

It’s not hopeless! There are several programs in place that help to ease the sting of student loans.

  • Under the Ford Program, a debtor can pay twenty percent of the difference between his adjusted gross income and the poverty level for his family size, or the amount the debtor would pay if the debt were repaid in twelve years, whichever is less. Each year the debtor’s monthly payment amount is adjusted to reflect any changes. The program requires making the specified payments for twenty-five years, and then the Secretary of Education cancels the remaining balance.
  • Income Based Repayment plans currently in place cap payments at 15 percent of discretionary income.
  • For newer loans, there is the Pay as You Earn program, which caps monthly payments at 10 percent of discretionary income, and after 20 years, the remaining balance is forgiven. If you work in public service, then after 10 years the remaining balance is forgiven.
  • President Obama just signed an executive order on June 9, 2014 that would expand the Pay as You Earn program, and to allow more borrowers to refinance their loans.

Check StudentLoans.gov for more information. Also, since some private loans can be discharged in bankruptcy, consult a bankruptcy lawyer to find out how.

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