Student loans and Bankruptcy
STUDENT LOANS ARE TOO LARGE AND CRIPPLING
Bankruptcy law has changed in many ways since 1978, when the bankruptcy code was written. The treatment of student loans in bankruptcy has been critical, increasing the huge amount of student loans now crushing the millennial generation. In the early 1980’s, after three years of collections of student debt, filing a bankruptcy allowed the discharge of all student loans. After 1986, the time that student loan lender could collect student loans, before they were subject to discharge in bankruptcy was increased to seven years.
Now. unless the debtor can prove that repayment of a student loan constitutes an "Undue Hardship", most student loans are nondischargeable.
What do these changes do for a lender? When the term that a loan could be collected before it could be discharged in bankruptcy was only three years, lenders had to be tight fisted and only loan what could actually be collected from some who would file bankruptcy, and those who would work to repay the debt. A rather harsh calculation.
When the term before a bankruptcy could discharge debts increased to seven years, the calculation for lenders could be less harsh. Much more could be collected and the amount lent increased.
Sadly, Congress was later stupid enough to make most student loans nondischargeable. This change meant much more could be lent. Not all would be repaid, but much more would be repaid if student loans could not be discharged in bankruptcy.
What does more student loans mean to the economy?
It means colleges can increase tuition and pay teachers more, build more buildings, essentially run on an unlimited budget. Colleges and Universities can and do, eat all of the extra money. Really, Congress did not anticipate that Colleges and Universities would simply expand fees to grab all of the extra money and give staff raises.
There were two ways Congress could have anticipated the cash flow that would evolve from the rule that all student loans became nondischargeable.
What does this mean?
There is no limit on student loans, so tuition and charges have no cap. By instituting student loans and not limiting them, government threw its ability to fund loans to the colleges and universities. This is not a normal market cap, the schools do not have to price their products so that people can afford to pay. The U.S.A., will pay, by guarantying loans. Essentially, by government getting into the business of over funding education, they have built another economic bubble of massive tuition charges. This is death to the millennials. The millennials are overpaying for education, the government has misread the deck, and millennials will have to pay many times more for their educations than anyone else has had to pay.
Why do I say that? I started law school in 1976. Tuition was $79 per unit. Law School requires 90 unites of study, so the price for law school was $7,110.00. Now the fees at the law school I attended are over $1.850.00 per unit, so the cost of law school is now $166,500.00. That is a rise of over 23 times the rate I paid my first year in law school, and it is unconscionable. The price could never have risen to $1,850.00 per unit if people had to pay the fees from their earnings. The law school would have had to cap their fees if the government wasn’t guarantying the skyrocketing tuition and fees.
The result is millennials who took student loans to go to college cannot afford houses. They cannot afford anything but repaying their student loans.
Sadly, parents of students who have signed guaranty's of said loans are also stuck with repaying them.
ARE ANY PARTS OF A STUDENT LOANS DISCHARGEABLE IN BANKRUPTCY?
The bankruptcy courts are struggling with which student loans are dischargeable.
The Bankruptcy code says many of them are not dischargeable, unless repaying them would be an "Undue Hardship" This was put in the law because congress believed that a person who has just finished a course of study that should be able to increase a debtor's income, should not be able to discharge the student loans without making an effort to repay the loans.
Many courts use the Brunner test to determine if student loans should be wholly, or partially dischargeable. The Brunner test came from a case involving Marie Brunner. She filed for bankruptcy just before her first student loan payment was due. The bankruptcy judge in Marie's case, granted her a discharge of her student loans, but the case was appealed. (see https://scholar.google.com/scholar_case?case=4172471159799328920&q=in+re+Brunner&hl=en&as_sdt=2006.)
The appellate court reversed and said Ms. Brunner had to show three things, or she should not be able to discharge her student loans.
1. That she could not maintain a "minimal standard of living", if she was forced to repay.
2. That the financial condition would likely remain during the loan term, and
3. That she had made a good faith effort to repay.
This is a hard test to pass. For example, suppose each of the spouses in a couple went to graduate school and left school with $125,000.00 of debt. The couple would have $250,000.00 of student debt, which they initially might struggle repaying, but who knows what is in the future for a couple with each spouse having a graduate degree? Part 2 of the test will be very difficult to pass for this couple.
So, the best candidate is a student who didn't get the degree finished and cannot get employment, or went to law school, tried and tried but did not pass the bar exam and cannot be an attorney. These things happen, some who finish medical school cannot pass the boards necessary to become licensed doctors.
Students who graduate, ask for deferments, and never start paying at all, are not likely to pass the third prong of the Brunner test.
One Bankruptcy case advises against applying for an income based repayment plan. Income based repayments plans are 25 years, and many student loans have a 7 year repayment term. The second prong of the Brunner test requires one to show the court that nothing is likely to change during the repayment term. So if you apply for an income based repayment program, and increase the term from 7 to 25 years, you may, depending where you live, have a much more difficult time proving your economic circumstances won't change. However, the District Court for the District of Kansas,held the extended term for an income based repayment does not apply, only the original loan repayment period. See:
ECMC v. Murray, No. 16-2838 (D. Kans.)
It is often easier to get an income based repayment program. Income based repayment programs review tax returns each year, and set a payment for the next year, based upon the debtor's income. After 25 years, anything remaining due is forgiven. These programs are called Ford programs, and some courts have ruled that the third prong of the Brunner test cannot be passed if the debtor has not applied (if eligible) for an income based repayment agreement. (This will become a Catch 22, as student loan debtors will have the Hobson's choice extending the term of their repayment, or suing quickly after finishing school. On the one hand, a court can say you fail the 3rd prong for not applying for a 25 year, income based repayment program, and on the other hand, say one cannot prove the economic situation will improve over the 25 years.)
If you qualify for an income based repayment program, apply. Every year you do not apply (if you cannot pass the Brunner Test), keeps you 25 years from having the debt forgiven. (but see new twist below)
Here in California, part of the Ninth Federal Judicial Circuit, some Judges will evaluate what part of a student loan can be repaid without undue hardship, and only discharge part of the student debt.
In order to have repaying Student Loans found to be an undue hardship, students have to sue and often have to go to trial to convince the bankruptcy judge the hardship is undue. It can be expensive, as this lawsuit is essentially a federal case. Bankruptcy courts are federal courts and use the Federal Rules for conducting cases (the Federal Rules of Civil Procedure, as incorporated into the Federal Rules of Bankruptcy Procedure) are used.
A new twist has popped up. One judge has ruled that the term during which it is unlikely to have income improve to the point a debtor can repay a student loan is the term of the loan. This means if one asks for an income based repayment, and the term is increased to 25 years, the debtor is between a rock and a hard place, as it is almost impossible to prove a debtor cannot repay student loans over 25 years. (See the Murry case, above, for the opposite view) One of the bankruptcy appellate panels recently ruled courts should consider whether a debtor can get and income based repayment program before discharging debt.