As of first quarter-2018, outstanding student loan debt reached a whopping $1.41 trillion, surpassing both credit card debt ($815 billion) and auto loan debt ($1.23 trillion) by billions of dollars.
Sadly, the current default rate is hovering at 18%, and that number is expected to rise to 40% by 2023. Note “default” means that the borrower has failed to make payment (or other arrangement) for 270 days or more. Particularly when dealing with federal loans, a declaration of default can have drastic and far-reaching consequences, which is discussed further, below.
Eliminating Debt Through Bankruptcy (Traditional Principles)
Originally, student loan debt was fully dischargeable in bankruptcy, albeit after a five-year waiting period. In 1990 this waiting period was extended to 7 years, and limits were placed on higher income/higher-net worth borrowers. By 1998, however, the law took a drastic turn, and incorporated the limitations of 11 U.S.C. 523(a)(8) which eliminated the 7-year waiting period. By eliminating the waiting period, it allowed for a borrower to discharge their student loan debt at any time, however, only if the borrower could establish “undue hardship”.
The Bankruptcy Code does not define “undue hardship.” Rather, the courts have dictated the legal standard, the most infamous of which comes from the Second Circuit Court of Appeals. The seminal case, Brunner v. NY Higher Education Services Corp., 831 F. 2d 395 (1987), imposed a three-part standard, now known as the “Brunner Test” and is applied by Bankruptcy Courts across the nation.
Under the Brunner Test, a borrower can only discharge student loans in Bankruptcy if they establish, by a preponderance of the evidence, three crucial factors:
(1) the debtor cannot maintain, based on current income and expenses, a minimal standard of living for himself and his dependents, if also forced to repay the student loans;
(2) additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period; and
(3) the debtor has made a good faith effort to repay the loans.
This makes for a very fact-sensitive assessment and provides broad discretion to judges in determining whether a debtor indeed qualifies for relief from student loan debt.
While the most extreme cases have proven successful, most borrowers do not suffer from extreme enough circumstances to entitle them for a discharge of their student loans, e.g., total and permanent disability.
Eliminating Debt Through Bankruptcy (New Concepts)
Note that not everyone struggling with student loan debt necessarily requires bankruptcy relief. In fact, is some cases it’s not helpful at all. Student lenders (in particular, the Dept. of Ed.) have various internal programs that may alleviate the burdens of student loan debt. For example, Income-Driven Repayment Plans, teacher and public servant forgiveness programs and several others (total and permanent disability discharge can also be sought outside of bankruptcy in some cases).
So how and why would someone choose bankruptcy? Well, for one, not everyone is going to qualify for one of the limited programs offered by their lender. And two, if you are already in “default” of your student loans, you automatically become ineligible for any of these programs . The key, therefore, is to avoid default, at all costs (unless your default is strategic, but that is a discussion for another day).
However, no one knows better than I do, that avoiding default is not always an option. When life “happens” we often divert our attention and resources to the most important expenses, like rent, food, and child care. Student loans are often the first expense to take a back seat, and let’s face it, 270 days goes by in the blink of any eye.
Some practitioners have taken the position that bankruptcy, even if discharge is not available, can be used to open the gates to mediation and other forms of settlement discussion. In particular, chapter 13, by design, forces creditors to come forward and identify themselves (and their attorneys), which is sometimes half the battle. This paves the way for discussion with another professional who knows the law and understands the reality of student loan default. While there is no guarantee, of course, it sure beats calling that same 800-number and talking to the hourly desk-jockeys that answer the phone between the hours of 8 a.m. and 8 .p.
The Tragedy of Default
Default starts with the first missed payment. This is called “delinquency” which is usually reported to the credit bureaus and can start to affect your credit score. Default, however, happens when you don’t make full payment for 270 days or more. At this point, most lenders will refer your account to a collection agency. It’s their job to endlessly harass you until you cough up a payment. If collections are unsuccessful, you may be referred for litigation, which more than likely will result in a judgment being entered against you in short order. With a judgment, the lender can garnish your wages, levy your bank accounts and seize your assets (such as your car or house).
However, if you default on federal student loans, the situation can be much worse. Thanks to the current laws, the Dept. of Education does not have to sue you before it can forcibly collect. They can immediately withhold your Federal payments (including tax refunds and social security benefits). Either way, you become ineligible for deferments, forbearances and other relief programs, and you no longer qualify for student loans. So if you had plans to return to school, think twice before allowing your student loans to go into default. It’s worth a mention here that state lenders can also reach into your pockets without first taking you to court.
To add insult to injury, even if you manage to stay out of default and, let’s say get approved for deferment or forbearance, you might be adding to your misery down the line. What most people don’t know is that even while in deferment or forbearance, the loan continues to accrue interest, unless you are specifically approved for a program that eliminates forward interest. So, while you might be enjoying a nice reprieve from your monthly payments, your overall balance is quickly rising at the rate of 6.7% per year (the current federal rate). In this scenario, you’re adding $6,700+to your balance, each year, for every $100,000 in student loans that you defer.
The moral of the story is ASK FOR HELP IMMEDIATELY. As you can see, there are a variety of options available to student borrowers, both in and outside of bankruptcy. But the longer you wait, the fewer options you have.
Still unsure about Bankruptcy? Read through many Frequently Asked Questions: https://leclawonline.wordpress.com/2018/06/14/bankruptcy-faqs/
Dispel all of your bad notions about Bankruptcy! Read Bankruptcy Myths Debunked!: https://leclawonline.wordpress.com/2018/12/18/bankruptcy-myths-debunked/
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