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To Cancel Student Loans in Bankruptcy, Your Future Must be “Hopeless”

There is nothing like being a graduate student who is potentially taking on a lot of loans to appreciate all those student loan articles that surface every fall. New York Times just published a great piece on what it takes to cancel your student loans. As many know, student loans, unlike almost any other type of loans such as home loans or credit card debt, are rarely discharged in bankruptcy. If someone wants to have his loans canceled, he would have to enter a completely separate process than normal bankruptcy and then prove to the judge that his situation is hopeless and his prospect for improvement is nil. The article describes it as such:

Most [judges] have settled on something called the Brunner test, named after a case that laid out a three-pronged standard for judges to use when determining whether they should discharge someone’s student loan debt. It calls on judges to examine whether debtors have made a good-faith effort to repay their debt by trying to find a job, earning as much as they can and minimizing expenses. Then comes an examination of a debtor’s budget, with an allowance for a “minimal” standard of living that generally does not allow for much beyond basics like food, shelter and health insurance, and some inexpensive recreation.

The third prong, which looks at a debtor’s future prospects during the loan repayment period, has proved to be especially squirm-inducing for bankruptcy judges because it puts them in the prediction business. This has only been complicated by the fact that many federal judicial circuits have established the “certainty of hopelessness” test…

Through my blog-life and real life, I knew a small handful of folks who have filed for bankruptcy. I have never, however, known anyone who has managed to get his or her student loans discharged. In fact, when I signed up for loans in college, a very colorful counselor described the loans as something we’ll have until: (1) we pay them off, (2) we die, or (3) we are so horribly maimed that we might as well be dead, which ever comes first. Not a speech a high schooler forgets.

Has anyone gotten their student loans canceled in bankruptcy? Do you think our current system for discharging student debt is too onerous?

  • Paige - I don't actually think the system is too onerous because I believe that people should pay off the debt that they incur. However, I do think that more education is needed before handing over such large sums of money to such young people. ReplyCancel

  • Caitlin - I read the article too, but I think you should also share the academic findings, which all said that it is worth trying to get student loans dismissed because you have something close to 50/50 shot if you have declared bankruptcy.

    I am glad to hear that b-school is going well. I am not sure if it is the different program or the economic times (we had just started our second year when Lehman went kaput) but it sounds like your classmates are much more financially responsible and just overall more mature. My classmates went through money like it was nothing because everyone was planning on getting the 6 figure jobs where one year's bonus would wipe their student loans. And good luck with the long distance marriage — I had a lot of friends with long distance marriages (sometimes international) and the good news is that they all made it through. It may be tough but I think it's easier to take the time to focus on yourself now than later. ReplyCancel

  • Nick - I know one person who won and know of hundreds who lost. From what I understand you really need to be so messed up that student loans are the least of your problems…

    Although I don't know everything about it, I'd like to see them more easily cancelled so maybe the schools will not hand them out like candy. Obviously making them virtually impossible to cancel hasn't stopped students from blindly signing up for hundreds of thousands of dollars. Maybe putting the risk on the lenders will help reduce open loan balances. I (and many others) believe that the rising tuition costs have been caused in part by the availability of student loans that people will just blindly sign up for, with very, very little price sensitivity. Hence, tuition rose really fast with the schools knowing that the increase in tuition will not reduce applications – it will just increase student loans…. ReplyCancel

  • moneyaftergrad - I'm probably stating the obvious here, but if we didn't make student loans so easy to get then they wouldn't have to be so hard to get rid of.

    "certainty of hopelessness" is pretty dismal, and I do think it's a little bit too harsh. All the punishment seems to be on the borrower and not the lender that gave them more than they could handle in the first place. It's unfair. ReplyCancel

  • Ben - I actually came out of business school with 80k of debt (a lot less than many because I cashed in a 401k to pay for the second year of education). One neat idea that I follow was:
    You can take money out of a 401k without the 10% penalty early withdrawal if you use it for educational expenses. If you take it out in the middle year of a full-time MBA, your income is low anyway, and you pay little income tax even before the non-penalty. So this way you get to pay for education with pre-tax dollars.

    I have scrimped and actually paid off the student loan now (foreign student with high floating rate interest loans).

    But as an intellectual exercise, I wonder if the following would work:

    Take out a home equity line of credit, use it to pay of a student loan…
    Wait the required amount of time to have any waiting periods/clawback period expire… Then default on the HELOC??ReplyCancel

  • plantingourpennies - My take-away from the article is that there is no clear standard for "hopelessness" – that even the Brunner test leaves much up to the discretion of the judge.

    I always wonder what if they changed student loans so that the amount and the interest rate were dependent on what you were studying… People would throw fits – but why are we encouraging $100K+ worth of debt for a degree in underwater basket weaving. Okay, so not REALLY underwater basket-weaving… but there are a lot of majors that you know are going to have a tough time paying the debt off. And yet, the rates are the same for all. From an actuarial perspective, it makes no sense since the risk/reward profile is completely different (as long as it's virtually impossible to get rid of the debt).

    Anyhow, that's my 2 cents. Which is likely worth even less than that. ReplyCancel

  • Amber - I get the personal responsibility arguments and all, but I don't think there is any reason in the universe why consumer debt should be easier to discharge than student debt. Why should "responsible" borrowing and "good debt" be more onerous than irresponsible spending? They can't take away your degree, sure, but they can't take away the fancy dinners you ate, either. ReplyCancel

  • kim - I'm a bankruptcy lawyer – it is exceedingly rare for someone to discharge student loans. The cases we read in law school allowing discharge involved stories like a woman so disabled that she could not work. I guess in Wallace's case, the judge decided that the blind can easily get a job because fo the ADA? The reason consumer debt is easier to discharge than consumer debt is simply the result of great lobbying by banks in the 1970s, and the ridiculous draconian 2005 bankruptcy "reform" act that only favored bankers. Regarding the "50/50 shot" – Western WA is much more lenient, being more liberal; think of the conservative ire against the 9th Court of Appeals. I wouldn't be so optimistic. ReplyCancel

  • apenny4athought - I know that student loans can be "canceled" after 7 years, but it's tough. Before that though, they won't even consider it. ReplyCancel

  • Little House - I don't know of anyone who's been able to get their student loan debt "forgiven" or canceled. There are a few programs out there for government workers – if the loans are paid for 10 years and the person is employed in a "government job" (like teaching or public service) the remaining portion of the loan can be forgiven. But there's a bit of paperwork to go through to get this so I'm not sure how easy or difficult it is.

    I also thought there was a "hardship" program as well that after 25 years of paying on loans, if there's a financial hardship the remainder could be forgiven. But I don't have much info on this. Anyone know about this? ReplyCancel

  • moneyaftergrad - Althought it'd be nice to be $60k free-er, I am not going to even attempt to cancel it. It seems pretty impossible and I know that I can pay the loans off, it just might take longer than I'd like it to. I don't understand why student loans aren't treated in the same way as any other loans and bankruptcy forgives them. Anyone know? ReplyCancel

  • Financial Directory - The student loan crisis is really a crisis that could and should have been avoided. To assume that one can find a better paying job if one has a college degree is very often a false assumption.. Break it down in fifths and you will most likely find that the 20 highest paid college grades out of a group of 100 make as much money as the other 80 college grades combined. This is something thats never talked about in the media. Instead its always college grades make twice as much money over a lifetime than high school grades. ReplyCancel

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