Some Borrowers Get Student Loans Discharged in Bankruptcy Court
Fact: 42 million Americans owe roughly $1.3 trillion in student loan debt. For those without the financial resources to pursue a college degree, student loans are a mixed blessing. Many students would not be able to attend college if they couldn’t borrow money. But the average student owes $31,000 after college – even more if they attend graduate school. That’s a big burden, though some borrowers recently have gotten student loans discharged in bankruptcy court.
Traditionally, borrowers have not been able to use bankruptcy to erase student loan debt. But according to the National Association of Student Financial Aid Administrators, some students with private student loans recently have been able to capitalize on the vagueness of such bankruptcy terms as “undue burden” and “extreme hardship.”
It raises some obvious questions: Why/how have they been able to do this? Should students be able to use bankruptcy for student loan debt?
Criteria for having student loans discharged through bankruptcy
Dr. Sean Stein Smith, CPA, CGMA, and member of the American Institute of CPAs’ National CPA Financial Literacy Commission, tells GoodCall® that he fully expects the topic of student loan debt to remain a high-profile issue that will increase the number of people looking to bankruptcy to discharge their debt. “But currently, one of the only paths to successfully having student loan debt discharged is to successfully argue that these loans were not for educational purposes, and this is usually determined on an individual basis through the court system,” Stein Smith explains.
It may sound impossible for a borrower to state that a student loan wasn’t for educational purposes. However, according to the Wall Street Journal, one borrower was able to get student loans discharged for the remaining balance on $15,000 borrowed to study for the bar exam. The borrower’s lawyer successfully argued that the money was more like a “consumer loan” than a student loan.
Another student profiled in the WSJ borrowed more than $160,000 to attend medical school in Senegal. However, this borrower’s lawyer said the school falsely claimed to be accredited. It was only when the student tried to take the medical board exam in the U.S. that the school’s fraudulence was discovered – and the medical degree was useless.
However, the hardship doesn’t always have to be extreme. One borrower took out $158,000 to attend a visual arts school in 2008 and now earns $45,000 a year as a retail employer. Before the judge ruled, she actually settled her case with her private lender.
Although these examples demonstrate the success that some students have had with getting student loans discharged, Stein Smith warns, “These determinations are made on a case by case basis, and this is not yet a generally applicable concept for discharging student debt through bankruptcy.”
For Stein Smith, the take home point is that it is difficult to have student loans discharged, so potential borrowers need to read the fine print before accepting loans. “Student loans are usually large debts that can have a long-term effect on your financial health and situation.” He recommends that potential borrowers thoroughly research their options and also consult with a CPA or financial planning professional if they have any questions.
For borrowers seriously considering the bankruptcy option
GoodCall@ asked Leslie H. Tayne of Tayne Law Group P.C., a New York state law practice that concentrates in debt management, debt resolution, and bankruptcy alternatives for consumers, to offer some tips to borrowers who may be considering bankruptcy as a way to get out from under the mountain of student loan debt.
Tayne staunchly advises against this route and uses bullet points to outline the factors involved in filing for bankruptcy, the effects of proceeding with it, and alternative solutions:
Tayne says it can be quite a difficult and complicated process to show undue hardship when trying to get student loans discharged:
- An “undue hardship” means you are unable to pay for your everyday needs for you and/or your family. For example, if you are in poverty or you have trouble putting food on the table, paying rent, have a minimum wage income, etc.
- The ability to have debt from student loans discharged also is dependent on your lender, the type of education you received, the type of school you attended, and where you borrowed your money.
- A student loan discharge via bankruptcy also requires you to possibly file a petition and go to court, which will require a lawyer (additional cost). It can become a long process.
Effects of filing for bankruptcy
For borrowers who choose this route to have student loans discharged, Tayne warns that this action will negatively affect their credit report for several years. “For example, completed Chapter 13 bankruptcies will be on your credit report for seven years and completed Chapter 7 will be on your report for 10 years.”
- How old will you be in 10 years? Will you need a loan in the next 10 years or maybe a credit card?
- If you are ever in need of a loan, new car, home, and the bank or credit union sees “bankruptcy” on your credit report, you have a better chance of being rejected for that loan.
- If you are a millennial and thinking about this option, then these are your prime years of financial opportunities! You may be looking to purchase an auto loan for that new car you saved for or take out a loan for your wedding. You may not be able to take advantage of these financial opportunities if bankruptcy is on your credit report.
Despite the burdens of student loan debt, few would argue that college is a worthwhile investment, although the wage premium between degree and non-degree holders is leveling off. However, some grads struggle to find jobs that pay well, which hurts their ability to make timely payments. A study by Consumer Reports reveals that borrowers who drop out of college have an even harder time repaying their student loans because they earn less. Even so, there are alternatives to bankruptcy.
Tayne advises borrowers to do some research on the following alternatives.
- For example, newly graduated students who can’t afford their monthly payments may want to consider “income-based repayment.”
- Students going back to school on at least a part-time basis may want to consider getting a deferment.
- Students should speak to their provider and a financial adviser or debt attorney to go over all options before choosing bankruptcy.
- Students should consider getting a part-time job or side hustle.