Dealing with Student Loans in and out of Bankruptcy
Without question, student loan debt is on the rise. The trend is likely due to a combination of factors, including a poor job market encouraging many to continue their educations, increasing tuition costs, and fewer parents with the financial ability to help out. The rising student loan debt stresses the budgets of many Americans and may be contributing to the delayed entry of young adults into the economy as they find they cannot afford to leave their parents’ homes, contribute to retirement, or make significant purchases like cars and homes.
Not only are more students graduating with student loan balances, but they are also borrowing more money for their educations. According to the Institute for College Access report, Student Debt and the Class of 2012 (http://projectonstudentdebt.org/), 71% of seniors graduated with student loan debt averaging $29,400.00. Another study by Fidelity found that the average had grown to $35,200.00 by 2013.
Repayment Begins but Default Persists
Upon graduation, a federal student loan borrower is given a 6 month grace period before starting the standard repayment typically amortized over a 10 year term. Borrowers can typically extend that repayment term through consolidation options and lower the monthly payment amounts. Often, though, many borrowers leaving school with student loan balances still find themselves unable to make even their minimum monthly payments. In fact, according to the Department of Education, the three year default rate for student loans is nearly 15%.
Deferments offer temporary assistance but all too often the borrower’s inability to pay back the loan does not improve and upon the expiration of the deferment he or she may find themselves in default of the terms of the loan. While rising debt loads combined with increasing default rates would normally lead consumers to consider bankruptcy options, student loan debt remains one of the few types of for which bankruptcy offers limited relief. In fact, student loan borrowers may find they have better options outside of a bankruptcy.
For most individuals, the assistance that bankruptcy provides comes in the form of obtaining relief temporarily from the draconian collection practices that student loan lenders may utilize. Federal loans, in particular, may be collected through wage garnishments, tax refund setoffs, and even social security payment intercepts. Even if a debt is not discharged by a bankruptcy, the case itself will provide at least temporary protection for the client from such collection pressures. While a typical Chapter 7 case would last only about 6 months, the period of protection afforded to a client can be as long as 5 years for Chapter 13 cases.
Beyond the temporary protections against collections, Bankruptcy can, in some rare cases, actually discharge the entire debt. Congress, however, has made the discharge of such debts extremely difficult by requiring a rigorous process with difficult evidentiary standards for the elimination of student loan debt. In fact, the process itself requires a separate federal lawsuit filed in addition to the Bankruptcy petition. These lawsuits are very expensive because the student loan lenders generally always vigorously defend them and exhaust all avenues of appeal if the borrower is successful at trial. Once the lawsuit is filed, the student loan client must prove to the Court that the debt imposes an “undue hardship” on the client and his or her dependents. 11 U.S.C. 523(a)(8).
What is an Undue Hardship?
The leading case establishing the test for “undue hardship”, Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2nd Cir. 1987), requires that all three of the following, simplified for purposes of this article, must be met. First the client must not be able to maintain a minimal standard of living if forced to repay the loans. Second, additional circumstances must exist that indicate that this state of affairs will persist for a significant portion of the repayment period. Third, the client has made good faith efforts to repay the loan. While this standard may not seem difficult for the struggling former student, in practice the Bankruptcy Courts have applied tests for determining the standard that are very difficult to pass. In light of the significant added expense of the required separate lawsuit and the low success rate of such efforts, few clients file bankruptcy for the sole purpose of discharging their student loans.
Outside of Bankruptcy, many avenues for relief do exist, although the process for obtaining such relief can be burdensome and requires navigating through complex eligibility requirements. This article summarizes the most common programs, but readers are encouraged to further explore whether they qualify for the relief offered. An excellent starting point for such research may be found at the Department of Education’s website: www.studentaid.ed.gov. Several programs exist to offer relief based on a borrower’s budget. Care must be taken to understand exactly which type of federal loan may be included in these plans.
Income Contingent Repayment Program
Certain federal student loans may qualify for income based repayment plans that reset the borrower’s payment about based on their budget. Once the borrower has paid such payment for 25 years, the balance of the loan is forgiven. Unfortunately under this plan, any forgiven indebtedness may be included as taxable income to the borrower unless certain exceptions apply.
Income Based Repayment Option
This program is also targeted to borrowers facing financial hardship and caps the reduced payment at 15% of the amount by which the borrower’s Adjusted Gross Income exceeds 150% of the applicable poverty level.
Pay As You Earn Plan
Pay as you earn plan is designed for borrowers with a financial hardship, and borrowers who have qualified for such plans may continue to make payments under the plan even if they later no longer have the initial financial hardship. The unpaid balance after 20 years of repayment under the plan is forgiven.
Other types of plans depend on the employment of the borrower and offer repayment and forgiveness benefits for those employed in certain types of work. While programs for teachers, government workers and charitable organization employees are described below, many other programs exist as well.
Government and Public Interest Jobs
Consumers with Federal Direct Loans may apply to have their outstanding loan balances forgiven after they have made 10 years of on time payments if they hold federal, state or local government jobs, or positions at a nonprofit that’s been designated as a 501(c)(3) tax-exempt organizations. Should the application for loan forgiveness be approved, the forgiven balance of the loan is not included as taxable income.
Educator Loan Forgiveness
Teachers should see if they’re eligible for the teacher loan forgiveness program. They must work at a qualifying school for five consecutive years to receive up to $17,500 in forgiveness on certain federal loans
Anyone struggling with student loan debt should take the time and make the effort required to pursue the repayment options, deferments, and forgiveness programs offered by their lenders. Not only will the borrower likely find better success with this approach, but such efforts will go a long way in to support a finding that they have made a “good faith” effort to repay their loans if they later attempt to seek relief from the loans in the Bankruptcy Court.