Student loans are the bane of higher education. They drive tuition rates up, leave entire generations of college students leveraged up to their necks and follow graduates around for years. The troublesome economy has left college graduates with little to no employment and huge amounts of debt. A study that tracked 2,300 students from 2005 to 2009 found that 45% of those employed earned less than $15,000 in 2010. (1) Student loan debt also began to outpace credit card debt in 2010. (2)
What’s more, student loans are considered non-dischargable debts. If graduates have to file for bankruptcy, their student loans are not erased. Despite this dire situation, there is one important exception. If the former student can demonstrate their loans represent undue hardship, they can be discharged or eliminated under bankruptcy. Undue hardship is a qualification that represents an extreme burden on the graduate or the graduate’s family.
The debtor has to meet with the judge presiding over his bankruptcy case and explain his hardship. This is very difficult to do unless the debtor has unusual circumstances. The criteria that must be met are:
– The debtor cannot maintain his current standard of living and make the payments on his loans.
– The debtor’s financial situation will probably continue.
– The debtor made sincere honest efforts to meet his payment obligations.
Proving all three points is next to impossible unless the debtor is physically disabled and cannot work. Debtors whose student loans make up the majority of their debt and are not disabled will likely not succeed. The consequences of defaulting on their loans are potentially severe.
In 2010, the federal government took over the student loan industry from private lenders. (3) Combined with the Higher Education Technical Amendments Act of 1991, this presents a serious problem for debtors who default. The HEA Act eliminated all statutes of limitations for schools, guaranty agencies or the government. If a borrower defaults on his student loans, the Department of Education can:
– Add collection fees and collection agency commission fees of 25% and 28%, respectively, to the principal and interest.
– Seize the debtor’s federal income tax refund until all of the defaulted loans have been paid.
– Garnish up to 15% of the debtor’s wages without suing the debtor first.
– Seize up to 15% of all monthly federal entitlement benefits including Social Security to repay the loans.
– Sue the debtor for the outstanding loan balances and place liens on the debtor’s property.
The debtor’s only hope if they cannot prove undue hardship is to file for Chapter 13 bankruptcy protection. The bankruptcy court will issue an automatic stay. This prevents the Department of Education and all collection agencies from attempting to collect on the value of the student loans.
Under Chapter 13, the debtor works out a repayment plan. This plan, when presented to the government, details the steps the debtor will take to repay their loans. The plan’s time frame can be up to five years. Importantly, the debtor can also challenge the total outstanding balance. If the debtor is successful, the balance will be reduced. The government must abide by the new balance even if the term extends beyond the end of the repayment plan.