You’ve likely heard that student loans aren’t dischargeable in bankruptcy. First, this isn’t true. For many low-income debtors, it actually is possible. Second, prior to the bankruptcy reform legislation of 2005, private student loans were able to be discharged in bankruptcy the same as any other private unsecured debt. Senator Tom Harkin (D-IA) is trying to get this protection reestablished as part of a larger piece of higher education legislation.
This year, the Higher Education Act is up for reauthorization. This is the piece of legislation that governs federal financial aid to college students. As part of the reauthorization, Harkin and his colleagues have prepared a draft, really a wish list, of what they’d like to see pass. Here are some of the highlights:
- Increase state investment to lower tuition costs to students
- Reinstate year round Pell Grants so students can graduate sooner
- Eliminate origination fees on some federal student loans
- Expand access to dual enrollment for high school students
- Streamline repayment plans by creating one simple income based option
- Auto-enrolling delinquent borrowers into the income based plan
- Allow private student loans to be discharged in bankruptcy
- Reform abuses and curb fees in the collections process
- Hold institutions more accountable for student outcomes
- Create a student complaint system to better track
- Standardizing award letters to make it easier to understand
- Improve entrance and exit financial aid counseling
These are all great suggestions that would benefit college students, but the private student loan bankruptcy line item is one of the biggest changes this legislation would enact if it passes. Because it’s a draft, line items will likely be stricken and there is a good chance that a great many of these won’t make into the final reauthorization language.
Currently, the standard for bankruptcy discharge is the same for both federal and private student loans. You must prove that paying your loans will pose undue hardship. This is determined by the Brunner Test – a three pronged standard that has become de rigueur in bankruptcy court. You must show that you cannot maintain a minimal standard of living if forced to pay the debt, the income limitation is likely to persist through the entire repayment period and that you have made a good faith effort to repay.
Student loans are the only debt, aside from certain taxes, alimony and child support obligations, that survive a bankruptcy filing. If this legislation passes as written, private student loans would receive the same treatment as any other unsecured debt during the bankruptcy process. But it’s important to understand this doesn’t mean that debtors can borrow willy-nilly and just have their debt written off.
The form of bankruptcy that allows most of your debts to be discharged is Chapter 7. There is a means test that debtors have to pass to be able to use this most drastic form of bankruptcy. Filers have to show that they don’t have the means to pay their debts, don’t have substantial assets and are unable to service their debts. Those that are earning a decent wage typically are more often required to file Chapter 13.
In Chapter 13, debtors get a three to five year repayment plan where they have to pay their current debts plus catch up back balances. At the end of the lengthy repayment plan, remaining balances on unsecured debts, like credit cards, are discharged. Most debtors pay a good bit toward their unsecured debts as part of the plan. So this means that most debtors won’t walk away from private student loans in bankruptcy scot-free.
You can read the draft paper here for the Higher Education Act reauthorization changes. And be sure to contact your Senators and tell them to support this key legislation. The modifications offer some really advantageous proposals for future college students, college students and graduate with debt.
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