Dischargeability of Student Loans in Bankruptcy

May 9, 2013

"The most terrifying words in the English language are: I'm from the government and I'm here to help." Ronald Reagan.

May 5, 1999, a day to be remembered. Why you ask? Well that was the day that Congress debated for three minutes and passed an amendment, offered by then Congressman and now Senator Lindsay Graham, which made privately-funded student loans non-dischargeable under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Continue reading to find out why there may be a possiblity to discharge your Student Loans in Bankruptcy

Student loans comprise the greatest amount of consumer debt in the United States, recently surpassing credit card debt. With the most recent recession and a stagnant job market, college graduates are suffering from the burden of overwhelming monthly loan payments on their staggering student loan debt.

HISTORY
The federal government meant well when it created student loan programs. The goal was to afford every child an opportunity to attend college. The loans were created to bridge the gap between student grant monies and the cost(s) of tuition, books and board.

PROBLEM
Student loans were created to supplement a student's educational costs. The loans were based on "need" rather than "creditworthiness." As a result, Congress felt student loans should not be discharged in a bankruptcy, except under extreme circumstances.

Congress in the late 1970's did not want the taxpayers saddled with the loss if a student defaulted on his/her student loan. For those experiencing a "partial financial hardship," the William Ford Foundation provided support in the form of the Income Contingent Repayment Program (ICRP) and the newer Income Based Repayment Program (IBR).

Both programs involve making a payment on the loans based not on the amount of the loans, but instead on the percentage (%) of the graduate's income. After a period of twenty (20) years, the amount of debt still owed would be "discharged" and no further payments would be required.

However, things did not go as planned. Federal government spending on higher education failed to keep up with the spiraling cost(s) of a college degree. Federal grant programs failed to cover the entire costs. As a result, students had to meet the rising costs by taking out a higher percentage of student loans. When federal government-insured student loans were exhausted, students had to borrow greater and greater amounts of privately-funded student loans.

THE PRIVATELY FUNDED STUDENT LOAN
Privately-funded student loans have a somewhat different structure. Whereas a government-insured loan might have a low interest rate, privately-funded student loans are usually higher in the rate of interest, a curb on the risk of student default. Most government-insured loans do not involve a co-borrower in the form of a parent, relative, or spouse. Privately-funded student loans commonly involve non-student third-parties who guarantee the debt in the event of student default. Both are common methods used by these lenders to reduce their risk and increase their profits. But does that not change the structure of the loan from one based on "need" to one based on "creditworthiness?" If I can charge more interest and involve guarantors, am I not using vehicles normally found associated with "creditworthiness." I think so. Therefore, should these loans be afforded the same protections of the government-insured loan,

WHAT HAPPENS IF A STUDENT CAN NOT AFFORD TO REPAY HIS PRIVATELY-FUNDED STUDENT LOAN?
If a student were to find him/herself unemployed, underemployed, or malemployed (working out of his/her field of study), would he/she be afforded the same remedies available to student loan borrowers suffering a "partial financial hardship" of their privately-funded student loans as those suffering a "partial financial hardship" of their government-insured student loans? NO WAY! Privately-funded lenders offer little to no programs to assist borrowers who suffer a "partial financial hardship." While extreme hardships are dischargeable in a bankruptcy just like the government-insured loans, what does a person who doesn't qualify for a "hardship discharge" do?

CONGRESS' INTENT
Congress intended the taxpayer to be protected from loss, not the lender. If you want to reduce your risk, by all means charge a higher interest rate, and incorporate a co-borrower. But do not expect to have your loan protected from discharge in the same regard.

BANKRUPTCY PROTECTION - ALL OR NONE
Currently, bankruptcy case law in the Middle District of Florida (comprising the Jacksonville and Orlando Divisions), operates from an all-or-none principle. You either qualify for a 100% hardship discharge of your student loans, or you qualify for a 0% discharge of your student loans, an extremely high standard with no middle ground.

While student loan debt may be non-dischargeable, there are ways to use bankruptcy to protect yourself and ease the total debt burden. Because student loans are unsecured debts, they are not allowed to be paid while in a Chapter 13 Bankruptcy unless you are paying the total unsecured debt 100%, which is quite rare. Chapter 13 cases last a minimum of thirty-six (36) to sixty (60) months, so the pragmatic reality is you might not be allowed to pay the student loans during the entire Chapter 13 case. As a result, you get a three (3) to five (5) year opportunity to get back on your feet while you are in the Chapter 13 reorganization.

Law Office of David M. Goldman is currently developing other methods to combat the burden of overwhelming student loan debt. Contact us today to speak further about these options.