The high cost of a college education forces many people to take out federal and private student loans. Federal loans offer several repayment options, including some tied to a borrower’s income with forgiveness of the remaining loan balance after 20 to 25 years. Private loans can sometimes be obtained at lower interest rates than those available on federal loans.
But even with flexible repayment options and favorable interest rates, the number of borrowers defaulting on student loans is high. The consequences of default are also high. Default on a federal student loan can lead to garnishment of wages without oversight by a court. It can also result in offset of tax refunds and government benefits like Social Security. Default on private student loans can also lead to wage garnishment.
While most debts can be discharged in bankruptcy, student loans have a special status that makes discharging them very difficult. However, there are some student loans that can be discharged in bankruptcy. Below is a description of what types of loans and in which situations it might be possible to discharge student loans in bankruptcy. Remember that these cases need to be brought before a bankruptcy judge who might view the law differently, so there is never a guarantee of discharge, but the following types of cases present the possibility of discharge of student loans.
- Private student loans to attend a school that isn’t an “eligible education institution.” Private student loans must be used to attend an “eligible education institution” for them to be non-dischargeable in bankruptcy. To be an eligible institution means the school can participate in federal financial aid programs. Most schools and colleges are eligible institutions but some aren’t For example, some for-profit unaccredited trade schools, flight schools and “diploma mills” aren’t eligible institutions. If a private student loan was obtained to attend an unaccredited school, the loan should be dischargeable in bankruptcy.
- Private and federal loans to students who aren’t “eligible students.” Schools wanting to enroll students who don’t first obtain a high school or GED must have the student take and pass an approved “ability to benefit” test. This test determines whether the student has competency in areas like reading comprehension and math to be able to benefit from attending college. If no such test was administered and passed before enrollment, a student without a high school diploma or GED should be able to discharge the loan.
- Private student loans obtained for expenses or services beyond the cost of attending school. A student loan that’s not dischargeable in bankruptcy must be obtained only for the payment of school expenses. If a private student loan is made for the purpose of paying other expenses, like payment of credit card debt, it should be dischargeable in bankruptcy.
- Private student loans for individuals not the debtor, the debtor’s spouse or the debtor’s dependent. Private student loan lenders frequently require a co-signer but the exception to discharge under the bankruptcy code only applies if the higher education expenses are incurred on behalf of the debtor, the debtor’s spouse or the debtor’s dependent.
- Debts owed directly to schools for tuition. Since the exception to discharge applies to “an educational benefit, overpayment or loan,” debts owed directly to a school for something other than the receipt of loan funds, grants or scholarships should be dischargeable. For example, tuition, book or room and board fees owed a college should be dischargeable. This exception to discharge has resulted in much litigation, but considerable caselaw supports the position that where no promissory note was signed and no grants or other funds were received by the debtor, the debt owed should be dischargeable in bankruptcy.
- Student loans where repayment will cause an “undue hardship” on a debtor or the debtor’s dependents. No exception to discharge has resulted in more litigation than this one because it relies heavily on the special facts present in each debtor’s case. In Iowa, the bankruptcy courts look at all the circumstances of the debtor’s situation to determine whether payment of the student loans would create an undue hardship. Many factors, including the debtor’s health, age, current and future income, expenses, amount of debt and the number and health and age of a debtor’s dependents, all play a role in determining whether the student loans cause an undue hardship.
Although discharging student loans in bankruptcy isn’t easy or often done, in some circumstances the discharge should be clearly available to a debtor. If you have one of the loans or situations mentioned above, contact Nancy L. Thompson Law Office, P.C. to see if you can be helped.