Discharging Student Loans and Bankruptcy
Author: San Diego Debt Relief
Synopsis and Key Points:
If a person filing for bankruptcy can prove undue hardship then student loans may be discharged by a bankruptcy court.
Main DigestStudent Loans: Help for the Future or Lifelong Burden? Student loans are non-dischargeable in bankruptcy. Is that about to change
College affords many with an opportunity for a better job, a better future. But, for many, paying for college is a struggle and help is needed. Much of that needed help often comes from student loans, both federal and private.
When these same people seeking better futures run into financial difficulties, though, that much-needed help to pay for college may become a lifelong burden.
When a borrower defaults on a loan for a house or car, that item can be repossessed by the lender. These types of loans are known as secured loans, as there is a tangible object that can be used as collateral for the loan. Student loans, however, are unsecured loans. This means that if the borrower defaults, there is no collateral for the lender to repossess because the loan was used to buy an intangible object (knowledge that cannot be taken away once learned).
This is important because in bankruptcy creditors are paid based on priority, and unsecured creditors have a lower priority than secured creditors. Meaning, unsecured creditors may only receive a portion of the loan balance.
This may also be part of the reason that the way student loans are treated in bankruptcy has changed over the years.
Student Loans and Bankruptcy
Starting in 1978, federal loans became non-dischargeable, while private student loans remained dischargeable. This change, according to a release by Senator Dick Durbin (D-IL), was meant to protect "federal investments in higher education." This was the law until 2005.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 changed the law to put private student loans on the same footing as federal student loans. So, when a person now files for bankruptcy, all student loans that are eligible as tax deductions are non-dischargeable. Meaning, even after bankruptcy, a person will still need to pay back his or her student loans.
There is one narrow exception to the non-dischargeability of student loans. If a person filing for bankruptcy can prove they create undue hardship, then student loans may be discharged by the bankruptcy court.
Proving undue hardship is very difficult. The court looks at each situation individually to determine if paying the student loans would be an overly burdensome on the borrower, then the student loans may be discharged.
A petition to prove undue hardship and discharge student loans is filed separately from the original bankruptcy petition and is an adversarial process. This means that the student-loan lenders are present to oppose the discharge by saying that repaying the loans is not and will not be overly burdensome upon the borrower.
For a court to decide that student loans are an undue hardship on the borrower, three elements must be proved:
1. Minimum standard of living - it must be shown that a minimum standard of living cannot be maintained while repaying the loans
2. Financial hardship will continue - it must be shown that the financial hardship of the borrower will continue over a significant portion of the loan period
3. Good faith effort to repay the loans - the borrower must prove that he or she had made honest efforts to repay the loan before filing for bankruptcy
Undue hardship is extremely difficult to prove, and may only be granted by the court in few circumstances, such as when the borrower has a prolonged disability.
Since the bankruptcy changes were instituted in 2005, Sen. Durbin has been working to revoke the special status that private student loans hold in bankruptcy. In the spring of 2011, Sen. Durbin, along with two other senators and four members of the House of Representatives, introduced legislation that would reinstate the pre-2005 bankruptcy standards as they relate to private student loans.
A release by Sen. Durbin calls private student loans "the fastest growing and most profitable part of the student loan industry." The release further states that the interest rates on private student loans are often as "onerous as credit cards ... with [some private student loan] interest rates of at least 15% and higher."
With little recourse for borrowers, even when they file for bankruptcy, Sen. Durbin feels that this bill is necessary to "restore fairness in student lending by treating privately issued student loans in bankruptcy the same as other types of private debt."
It is unclear whether Sen. Durbin's legislation will pass (he has introduced similar legislation in the past few years that has not passed).
Even though bankruptcy may not eliminate student loan debt, there are still options for those that need help with their student loans.
Money-zine.com outlines a few options, including:
- Deferment - under certain circumstances, a borrower may be able to suspend his or her student loan payments for a period of time
- Forbearance - by working with a lender, a borrower may be able to postpone or reduce student loan payments until a period of financial hardship ends
- Consolidation - a borrower may be able to consolidate his or her monthly payments into one payment, which may lower the monthly payment amount
- Payment Options - a lender may offer different payment plans, including graduated payments or income-based payments
Student loans impose a significant burden on those with financial troubles. However, there are options to help with this difficult situation, from working with the lender to filing for bankruptcy to eliminate non-student loan debt. An experienced bankruptcy attorney can help you decide on the best course of action for your specific situation and help you rediscover hope for the future.
Article provided by San Diego Debt Relief - Visit us at www.sandiegodebtrelief.org
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