When it comes to debt, student loans are in a class by themselves. It is the only type of consumer debt for which virtually all standard consumer protections have been removed. Student loans are not dischargeable in bankruptcy, except in rare and extreme cases. Federal loans are not subject to any statute of limitations: the government or the lender can pursue repayment as long as the borrower is alive.
Federally guaranteed student loans were first available after passage of the Higher Education Act of 1965. In 1976, Congress passed a law making student loans non-dischargeable in bankruptcy during the first 5 years after the student graduated or stopped attending school. That period was later changed to 7 years. The 1998 Higher Education Act changed the law again and removed the option of bankruptcy discharge for federal student loans. These changes were made with no regard for the impact they would have upon student borrowers.
The 1998 law also made it possible for lenders to charge sizeable penalties and fees for late payments and defaulted loans. Many borrowers have reported that their original loan balance doubled or tripled over time after the default, making it even more impossible to envision a payment plan that would make a dent in the balance.
Many borrowers can pay their loans on time and pay them off while they are still young. But changes in the law from 1998 to 2005 have been detrimental to those who borrowed heavily for their education, or co-signed a loan for a family member, and are unable to make the payments. Lenders and collection agents now seek to collect defaulted loans as long as the borrower lives, and can even garnish 15 per cent of the debtor’s Social Security benefits decades after a default.
If you cannot repay your federal student loans, you must contact your student loan servicer to request a deferment or forbearance. For some loans, although you qualify for the deferment or forbearance, interest is added to the loan, causing the amount you owe to increase.1
Described below are two options available to borrowers who have received federally guaranteed student loans and are struggling to make payments.
Income Based Repayment (IBR)
If you cannot afford your student loan payments on your current income, and have not defaulted on your loans, you can apply for Income Based Repayment (IBR), or for other “income-sensitive” payment plans that have been made available to new borrowers in recent years. Payments are based on income and family size. After the required period of repayment (typically 20 or 25 years), the remaining balance is cancelled. Unfortunately, any debt that is cancelled is treated as income, and you may owe income tax on that amount.
Total and Permanent Disability (TPD)
Student loans may be discharged if you have a total and permanent disability (TPD). The Department of Education considers you totally and permanently disabled if you are unable to engage in any substantial gainful activity due to a physical or mental impairment that:
- is expected to continue indefinitely or result in death;
- has lasted for a continuous period of at least 60 months; or
- can be expected to last for a continuous period of at least 60 months
To qualify for this discharge, a physician must certify that you are totally and permanently disabled according to the above definition. If the discharge is granted you will be monitored for a period of three years, and during that time, you may not have income that exceeds the poverty level for a family of two in your state.
The Department of Education is required to report a discharge (of any amount greater than $600) to the IRS as income in the year that the loan was discharged.
These situations may also lead to cancellation of your student loans:
- The school closed before you completed the program.
- The school forged the signature on your promissory note or falsely certified that you were eligible for aid.
- The loan was falsely certified through identity theft.
- The student withdrew from school but the school didn’t pay a refund that it owed.
(For more information about federal student loan programs, see the Links page.)
Hardship Discharge of Student Loans in a Bankruptcy Case
Most bankruptcy attorneys do not recommend that clients attempt to discharge their student loan debts in a bankruptcy case. There are at least two reasons for this. First, the discharge of a student loan must be attempted through a mechanism known as an “adversary action.” That is essentially a lawsuit filed in the bankruptcy court. In nearly every case the lender or the government will litigate the adversary action and attempt to prevent the discharge. The time and resources involved in this process leads to significant legal costs that most (if not all) student loan debtors cannot afford to pay.
Secondly, the bankruptcy court’s power to grant a discharge of a guaranteed student loan is based on Section 528(a)(8) of the bankruptcy code, which permits a discharge only if repayment of the loan would cause an “undue hardship.” This term is not defined in the bankruptcy code, so courts had to develop criteria to determine when repayment of student loans should be excused.
California bankruptcy courts use the following “undue hardship” test:
- the debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the loans;
- additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and
- the debtor has made good faith efforts to repay the loans
The “additional circumstances” requirement has been interpreted to mean that the that debtor must show that he has made a long-term effort to generate income; that options to generate more income are simply not available. The debtor must also show that he has a very modest standard of living, and that he is unable to cut expenses further.
In rare cases a debtor may be able to show that she has worked diligently and reached the maximum income possible for her skills and education, but can still afford only basic living expenses. (See In Re Nys 308 B.R. 436) The common situation of a younger debtor who has borrowed heavily but who is not disabled or supporting a disabled family member would probably not be succeed in getting a discharge under this test. However, a very large debt in combination with other factors, such as a large family to support, may result in a partial or complete discharge.
- Brunner v. New York State Higher Educ. Servs. Corp., 831 F.2d 395, 396 (2d Cir. 1987); United Student Aid Funds, Inc. v. Pena, 155 F.3d 1108 (9th Cir. 1998)