Student Loan Debt and Bankruptcy
“How The $1.2 Trillion College Debt Crisis Is Crippling Students, Parents And The Economy” – Forbes
“Student Loans Are Becoming a Drag on the US Economy” – Time Magazine
These are just a few of the headlines from the past year about the increase in student loans and the default rate that many economists and lawmakers are concerned about. Beyond policy-makers however, student loan debt takes it toll on individuals and families everyday. To make matter worse, the bankruptcy laws, which were changed in 2005 just prior to the recession, do not allow for the legal discharge of student loan debt within the usual bankruptcy process. Instead, borrowers must engage in an additional legal process to ask the court to rule on the discharge of student loan debt.
If you do a web search of student loans and bankruptcy, you will see that almost every entry says that student loan debt cannot generally be discharged. Let’s look more closely at this. In fact, it is true that the bankruptcy laws do not allow you to discharge debt through normal bankruptcy procedures. In order to get a discharge, you must file what is called an “adversary proceeding.” Another belief is that very few debtors are able to prevail in the adversary proceeding. It is also true that overall, the number of student loan discharges is very, very small in comparison to the total number of bankruptcies filed. And finally, It is also believed that it is difficult to receive a discharge because of the requirement of showing that continuing to pay the student loan will result in undue hardship to the debtor and their dependents. Let’s look more closely at these assumptions.
Because there is additional proof needed to show undue burden, the majority of those individuals who file bankruptcy do not file the additional adversary proceeding necessary to receive a discharge. This accounts for very low number of student loan discharges given to debtors by bankruptcy courts each year.
The majority of courts will rely on three factors when deciding on student loan discharge. Can the debtor maintain a minimal standard of living if they have to repay the student loan? Is the current state of their financial affairs likely to continue in the future for a significant part of the loan repayment period? Has the debtor made a good faith effort to repay the loans? The judge in each proceeding must consider all of the facts in each individual case.
Even though there is a common belief that debtors will have difficulty getting student loans discharged during bankruptcy, a recent study by Jason Iuliana sheds light on this complex issue. In a review of adversary proceedings to determine if debtors have a fair shot at eliminating student loan debt in bankruptcy, Iuliana looked at the number of adversary proceedings that were filed, as well as the outcomes of those proceedings. What he found was that “…barely 0.1 percent of student loan debtors in bankruptcy sought to discharge their educational debts. This figure illustrates the central flaw in the system: 99.9 percent of bankrupt student loan debtors do not even try to discharge their student loans.”
The majority of research done prior to his study looked at the outcomes of cases that were either settled or reached a verdict at trial. He looked at a broader sample and found that 4 out of 10 student loans were fully or partially discharged after the debtor filed an adversary proceeding. Because 99.9% of individuals filing bankruptcy who have student loans do not file an adversary proceeding, the number he looked at was a total of 207 cases. Though a small number, his findings are important. Contrary to many of the beliefs about the difficulty of obtaining a discharge for student loans, Iuliana discovered that almost 40% of student loan debtors received some kind of discharge of the loan debt. He also discovered some other interesting and important factors.
For example, he found that the financial situation of those who filed adversary proceedings and those who did not file were much the same. Both groups faced similar levels of financial difficulty. After filing the adversary proceeding, there were three possible outcomes. Debtors could receive a full discharge, partial discharge, or no discharge. There were three common factors for whether or not the debtor received a discharge. First was whether the debtor had a medical hardship. Second was whether the debtor was employed. Third was what the debtor’s income was the year before filing bankruptcy.
Iuliano states, “Whereas seventy-three percent of people who did not have a medical hardship failed to receive any type of discharge, the same can be said about only forty-eight percent of debtors who had a medical hardship. Similarly, forty percent of unemployed debtors received a full discharge, but only sixteen percent of debtors with a job received a full discharge.” The upshot of his study shows that if there was a medical hardship and/or the debtor was unemployed, they had a much greater chance of have their student loans discharged.
He goes on to ask, “Why do so few people in bankruptcy attempt to discharge their student loans? A couple reasons likely account for this phenomenon. First, the view that student loan discharges are nearly impossible to obtain may be a self-fulfilling prophecy. As mentioned earlier, journalists and academics have long asserted that it is nearly impossible to meet the undue hardship standard. If debtors take these comments to heart and believe that their chances of success are trivial, they will be less likely to attempt to discharge their educational debt. Judges grant so few discharges simply because they hear so few student loan cases. Unfortunately, with judges granting so few discharges, commentators feel even more justified in arguing that the undue hardship requirement is too harsh. Thus, the cycle continues. The data dispel the myth that it is nearly impossible to discharge educational debt. Thirty-nine percent of debtors who filed an adversary proceeding received a full or partial discharge.”
As a bankruptcy attorney, I frequently see the impact of student loan debt on my clients. Clients are not just numbers or statistics. They are people with families who are doing their best under very difficult financial circumstances to meet their obligations and build a future. Part of my commitment to assisting clients is to ensure they use all of the legal processes available to them to even the playing field between creditors and debtors. Even if it is determined that the debt cannot be discharged under chapter 7 or 13 bankruptcy, the bankruptcy laws can provide relief in other ways.
Since the recession began in 2007, student loan debt has been on the rise. Consumer debt hit its peak in 2008 and student loan debt is the only debt that has increased since then. Student loan debt levels are higher than credit card debt and auto loans. They are now the largest form of debt besides mortgages. Over an 8-year period between 2004 and 2012, there has been a 70% increase in the number of borrowers and a corresponding 70% increase in the average balance carried by individuals. (Federal Reserve Bank of New York, March 2013).
Between 2001 and 2011, total borrowing for undergraduate students increased by 56%. (Department of Education) According to the Project on Student Debt, 7 out of 10 undergraduates in 2012 came out of college with an average of $29,400 in student loan debt. The average in Arizona was lower at $20,299 with about 54% of college graduates carrying loans.
Student loans are offered by the federal government and through private lenders. The Stafford loan program is the most common federal education loans received by students. They can be subsidized or unsubsidized. When a student receives a subsidized Stafford loan, the interest is generally paid by the government while a student is in school. In an unsubsidized Stafford loan the interest accrues while a student is in school, but they are not required to pay until they are no longer in school.
There is also the Perkins loan. This is loan is designated for students with very high financial need. Interest is capped and subsidized while a student is in school. There are also loans for parents (PLUS loan), private loans, and state loans. Students and parents can take out loans for attending public colleges, private colleges and for-profit colleges.
For consumers who are in their student loan repayment period, about 6.7 million (or 17%) are 90+ days delinquent in paying back their loans. Many people believe that the largest percentage of individuals who are delinquent on their loans are recent graduates who cannot find jobs. Although there is certainly a large percentage of individuals in their 20s who are delinquent, the largest group are those ages 30-49. Since 2004, the delinquency rate has risen more than 30%. (Lee, Federal Reserve Bank of NY, 2013) Delinquency on student loans generally means that the individuals and families are delinquent on other loans. The burden of student debt can also mean that new graduates delay other decisions such as marriage, home buying, even starting a family.
In a recent case that was decided in 2013 by the 9th Circuit Court of Appeals (which includes Arizona), Michael Hedlund received a partial discharge of his student loans. He owed approximately $85,000 in student loans after completing his undergraduate and law school degrees. Hedlund was granted a partial discharge after filing an adversary proceeding during his chapter 7 bankruptcy process. The decision of the bankruptcy judge was appealed and the district court reinstated the student loan debt in full. The 9th Circuit Court of Appeals decided that the bankruptcy court was correct in granting the partial discharge.
Hedlund, after filing the adversary proceeding came to a settlement with one of the lenders, who agreed to have him pay $50 per month to pay off $17,000. His overall payments prior to bankruptcy were over $800. In considering whether or not to uphold the partial discharge, the court of appeals reviewed the bankruptcy judge’s decision to ensure that the judge had not made an error in interpreting the facts of the case. The bankruptcy judge noted that because Hedlund had waited 4 years before filing bankruptcy and had endured 16 months of wage garnishments without challenging the garnishment, while also making a $900 voluntary payment upon receiving a $5,000 inheritance, he had in good faith tried to pay back the loan.
It is important to note that filing the adversary proceeding accomplished two things. First, it motivated one of the student loan lenders to renegotiate the terms of Hedlund’s loan. He was able to get a favorable concession from the lender when faced with the possibility of having the entire loan discharged by the bankruptcy court. The second noteworthy part of the decision is that Hedlund was able to have over $50,000 discharged by the bankruptcy judge and this was affirmed on appeal by the 9th Circuit.
When filing for bankruptcy, I start by letting my clients know that student debt cannot be wiped out without filing an adversary proceeding outside of the normal bankruptcy process. However, even within the bankruptcy process, we have one of the most powerful tools on our side, the automatic stay. Immediately after filing bankruptcy you are legally protected from creditors trying to collect on the debt you owe them. You do not have to make payments during the bankruptcy process, however, interest will continue to accrue on those student loans.
Over the course of a chapter 13 bankruptcy, the automatic stay may remain in effect for 3 to 5 years, during which the lender cannot harass or come after you in any way. In a chapter 13 bankruptcy, student loans are nonpriority unsecured debts. So depending on your income and expenses, some portion of your loan may be paid as part of the bankruptcy payment plan. Even if after an adversary proceeding, your student loan is not discharged, it may be that during the 3-5 years of making lower payments and discharging other debts, you are be able to afford to pay the full payments once you come out of bankruptcy.
In a chapter 7 bankruptcy cases, your non-exempt assets are sold (or liquidated) and used to pay off your creditors. Again, even if the student loan is not discharged in the adversary proceeding, the discharge of other debts can provide enough financial breathing room so that you are able to make the necessary student loan payments and move forward financially. Even as the student debt crisis looms on the horizon, it is possible to use the bankruptcy process and the adversary proceeding to create a fresh start after facing significant financial difficulties.