How to Discharge or Manage Student Loans in Bankruptcy

First confirm the loan can’t be discharged in bankruptcy

When a lawyer assumes that a student loan cant be discharged it may be malpractice. Some student loans are just as dischargeable as income taxes you just have to wait the correct amount of time. Other “student loans” may be as dischargeable as a credit card. If you just assume it is not dischargeable and fail to do the analysis the student loan debt will not be discharged. About 35% of student loans are in default. If you think you can’t manage, bankrupt or discharge your student loans think again. The get out of debt guy reported 2012 data showing that of the bankruptcy cases that filed for a student loan discharge 47% were discharged in full, 21% resulted in a better payment, and 12% settled for less than was due. That is an 80% success ratio. Three prior studies on student loan discharges in bankruptcy including those from Iuliano and Pardo and Lacey show similar results with about 40-50% success rates. The reason for these high ratios may be that lawyers are getting better at spotting what student loans qualify for the undue hardship. Some cases were won by default simply because the lender failed to file an answer and other studies show the case for partial discharges Bayuk. Here is the Student Loan Undue Hardship Flowchart showing how to analyze a Student loan.

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Until 1998 student loans could be discharged just like any other debt if they had been due for 7 years. After 1998 loans insured by the Department of Education or a state agency to Students attending “qualified schools” were made non-dischargable unless that loan was an undue hardship. A special lawsuit called an adversary proceeding had to be filed in bankruptcy court to discharge the student loan. This is extra work for the attorney which clients often don’t want to pay for. How do you know if your school was “qualified”. Look at the list of qualified schools. If your school isn’t on the list of qualified schools, it isn’t a qualified school and the loan is just as dischargeable as any credit card debt. Only loans through accredited schools are protected from discharge.

From 1998 to 2005 private student loans were discharged like credit card debts. If you filed a bankruptcy prior to 2005 any private loan was probably discharged automatically. No adversary filing was required. If a debt collector makes any attempt to collect for these loans he has probably violated the fair debt collection practices act and also is in contempt of the bankruptcy court. Bankruptcy cases filed after 2005 made loans from private banks non dischargeable unless the school was qualified and the student could prove an undue hardship.

But presently VA school loans can be discharged in bankruptcy after 5 years under 38 USC 7634 without filing an adversary. Military service loans generally also have a 5 year waiting period under 37 USC 303a(e)(4) but the Troops to Teachers program totally bars any discharge 20 USC 6674(f)(3) even if it is an undue hardship. Only Department of Education, State agencies and private loans require an undue hardship to discharge the loan. The Heal loan standard is even harder than the undue hardship and requires that requiring payment would be “unconscionable” 42 U.S.C. Section 292f(g). A debt for rent or any other service from a school is not a loan and is dischargeable even a debt for tuition. Only educational loans are not dischargeable unless undue hardship is proven. Unless you signed a loan an ordinary debt such your dorm rent is just as dischargeable as a credit card.

Second, Government Loans have programs that allow you to manage or discharge their loans.

Fortunately the government has many programs that allow you to discharge or get a government loan out of default. Always check to confirm if the debt is government or private by signing into the National Student Loan Data System and creating an account and looking up whether the loan is a government loan. Some government loans made in the 1970s may not show in their results but how to handle the loan is governed by whether or not the loan is Government or private. If the loan was cosigned or has an adjustable or high interest rate it is probably private. Some of the private loan rates are at credit card levels. Government loans have administrative powers that allow garnishments by merely sending a notice which is only required to be sent not received.

You can rehabilitate Government loans

Government loans can be brought up to date by the rehabilitation program. This requires applying for the rehabilitation program which must offer you affordable payments which are as low as 5 dollars. Generally, by making 9 of 10 on time payments your credit history will have a new notation that you have been paying “on time”. This program will allow you to purchase a home if a student loan default has been hampering your credit history. You can normally only rehabilitate a loan one time but normally you have to rehabilitate the loan to get an IBR loan.

Combine Government loans into IBR or ICR

IBR or income based repayment plans allow you to combine government loans into what should be an affordable repayment which is never more than 10% of income based on a sliding scale of 0% at the poverty level to 10% at the highest income. At the end of 20 years the balance is forgiven (discharged) if the loan is kept in a good payment status until it is discharged. The old IBR program was 12% max for 25 years. Payments are as low as 0 dollars for IBR and since the program rewards you for every year the loan is repaid you never want to use an unemployment deferment or forbearance for IBR and public service loan programs. For the years you have zero income just send in your zero payment while on unemployment or social security. Parent Plus loans may need to look at the ICR program which is very similar. The ICR has a difficult formula and the IBR generally has lower payments. If you work for the government or a non profit entity like a Hospital, Charity or School the public service program allows you to pay off the IBR loan within 10 years with 10% of the loan repaid for every year. Church employees that do non religious work qualify for the public service program. Even doctors qualify. Just fill out the form.

Government loans have various programs to discharge loans closed school, death, disability

Not only does rehabilitation and IBR exist for government loans but several other programs to discharge government loans exist. Some programs defer payment. In a deferment the government pays the interest in a forbearance interest continues to accrue. If a school closes a program and you can’t complete the program you may be able to discharge the debt as a closed school discharge. Other discharges exist such as a discharge for parents when a child/student dies The common administrative discharges are disability, Public Service Loan Forgiveness, death and school closing. But several other administrative discharges do exist such as stolen identity and failure to benefit and these discharges can be reviewed on the DOE website. A person that can’t possibly benefit from the training may be able to qualify for the administrative failure to benefit if the person could not qualify for the certification/job when he attended the school such as a blind student who attends a truck driving school for a CDL license.

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Third, Private Loans the Statute of Limitations and other defenses

Private student loans are basically no different than a credit card with one exception. Since 2005 they cant be discharged without filing an adversary proceeding for undue hardship. However private loans are much easier to discharge as an undue hardship since they have no programs that allow the debt to be discharged upon disability, failure to benefit, or other conditions. Private loans can only be discharged in bankruptcy, go into default or paid on time. It is therefore much easier to prove that a private student loans creates an undue hardship. Private loans depend on your voluntarily paying or upon suing for the debt. They cant administratively attach tax refunds or wages without suing like the Department of Education.
All of the normal defenses you can make against a credit card such as the Statute of Limitations apply to private student loans. Common defenses like the SOL and infancy do not apply to government loans. The fair debt collection practices act only applies to loans in default which happens to government student loans when they are about 270 days overdue and to private student loans when they are 1 day overdue. Debt collectors who are attempting to collect a private loan will often claim that the loan is a government loan in an effort to claim that the statute of limitations does not apply to them. This is another reason for checking to see if the loan is government or private. Other defenses may include real party in interest. All of the defenses that can be used against any common debt apply to private student loans. Some states have 3 or 5 year Statutes of Limitations. Some states will toll the statute (restart the clock) if you make a payment. Kentucky has a 15 year SOL and any payment restarts the 15 year period.

Fourth, Discharging student loans in Bankruptcy the Undue Hardship Standard

A Debtor is required to prove that he “would be unable to maintain a minimal standard of living if forced to repay student loans” to prove an undue hardship and discharge a student loan in bankruptcy. This requires you to document past, present and future good faith efforts and inability to repay. This includes:

  1. your inability to pay the minimum student loan payments.
  2. your income
  3. your required and basic expenses such as food, health-care, housing, and transportation

If there is proof of undue hardship and you have a condition that “makes it unlikely your situation will improve” gather the evidence to prove it. This may be any evidence and condition showing your income or expenses will prevent you from paying a student loan for a long time such as disability.

You will have to prove that you have made a “a good faith effort to repay your loans” which often includes placing government loans into an IBR income based repayment plan. Private loans are much easier to discharge in bankruptcy, because there are few or no programs for private loans. The only available options for private loans are pay in full or default. Proof that you made these good faith efforts and requests include proof of the telephone calls, letters, applications, deferments and forbearances. It’s your burden to prove that you made every effort to repay. You have to prove that an undue hardship discharge is the only option left to get the undue hardship discharge. This is very difficult to do but 40-80% of the people filing for undue hardship from 2005 to in 2012 were able to get better terms than what they had prior to filing.
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