It is just a fact that the over one trillion (uh,  yeah, not billion, not hundreds of billions, trillion) dollars of student debt now outstanding in our fair land will not be repaid.

Because the graduates will not generate sufficient income to pay it back.

The jobs they were told were out there for them are not there.  Of course, that big increase in degree programs colleague Chip Parker wrote about is one of the symptoms.

Another one is unjustified tuition increases by colleges, who already have enough money, but know their customers can get more student loan money to buy their product.  Which they do, mostly because they do not understand what paying it back means to their lives.

I take issue Mr. Parker’s statement that student loans, like mortgages are a necessary evil.

We will save that debate for another time.

The problem on the table is what to do about the debt that is already out there.  It is not currently dischargeable under bankruptcy law, unless the debtor can prove it would be an undue hardship to have to repay it.  Very little student loan debt is resolved by this method.

What if this debt cannot be discharged in bankruptcy?

We will have thousands of students shackled into debt.

(image credit: dreamstime)

So, who should take the hit?  What about the banks that lent the money?  Oh, sorry, I forgot.  This is America.  The banks NEVER take a hit.  Most of this debt was guaranteed by, or to, the government anyway.

The universities?

Should they be required to pay all or some of the debt their graduates cannot pay?

Nearly seventy universities in the U.S. have endowments of over a billion dollars.  They are the ones who are supposed to be making the students job worthy.  Big paying job worthy.

Boy, I love this idea.  As you can tell from Chip’s post, being that faculty number and salary have not increased during the last decades of tuition inflation, funded by easily obtained student loans, where did the money go?

“If the professors are not getting this booty, it must mean the administrators are. “

Still, very difficult to work out the details on this one.  Probably would require a whole new bureaucracy.

So what are we left with?

The students?

Calls to return bankruptcy laws to the days when student loans were dischargeable are increasing, even law professor Glen Reynolds, considered a conservative (actually, libertarian) blogger (Instapundit) has joined the chorus.  Glen has long written about the unsustainability of the student loan bubble.

Something will change.  We just have to work out what it will be.

Although for-profit colleges, which typically serve low-income students, enroll only about 10 percent of the nation’s undergraduates, they are responsible for nearly half of all defaults.  Sound familiar?  Think subprime lending housing crisis.

There is a proven formula in this country of profiteering at the expense of the poor, and these for-profit colleges are no exception.  These businesses get 80% of their revenue from student loans and have dropout rates nearly as high.  Senator Tom Harkin (D-IA), Chairman of the Senate Health Education Labor and Pensions Committee, recently stated:

For any student, loan default is a heartbreaking situation with long term consequences. . .  Today’s data should give us further concerns about whether some for-profit colleges are doing enough to help their students succeed.  The cohort default rate at for-profit schools rose much faster than at public and nonprofit private colleges in 2009, and for-profit college students are more than twice as likely to default on their loans as public college students, and three times more likely than private nonprofit college students.  Coupled with sky-high tuition costs, alarming drop-out rates, poor job placement services and the many other bad practices that we’ve uncovered in the HELP Committee’s investigation, it is clear that the for-profit education industry needs greater oversight in order to ensure that students and taxpayers are getting a good value for their investment in these schools.

Okay, so they’ve identified the problem, but what’s the solution?  Congressman Hansen Clarke (D-Mich.), has the right idea – make these for-profit college student loans dischargeable in bankruptcy.  Currently, student loans are a rare exception to the bankruptcy discharge, meaning that only in extreme circumstances will a debtor be able to escape that financial obligation.

While it might seem fair to make student loans “bankruptcy-proof,” the result of this exception has been an erosion of our stature in the educated world.  The United States is no longer viewed as the pinnacle of higher education.

A couple years ago, I discussed the inverse relationship between the rising cost of education in this country versus the quality of education.  According to The National Center for Public Policy and Higher Education in its 2008 “Measuring Up” Report, the cost of obtaining a college degree historically grows at a pace 4 times faster than the rate of inflation. By comparison, medical costs, which are routinely described as “soaring”, grow half as fast as education costs.  At the same time, the U.S. inexplicably ranks a dismal 15th in the percentage of population with a higher education degree.

There has been a flood of investment dollars into the student loan industry over the last two decades as a direct result of excepting student loans from discharge. The investor’s capital is more secure, as there is a greater probability of eventual repayment.

The desire to maximize the student loan market has frequently lead to abuse and fraud by lenders and educators.  Remember back in 2007 when Sallie Mae, the nation’s largest student loan lender, was fined $2M for creating a student loan scheme involving 19 universities?

And now, with the news about astronomically high default rates in the “for-profit college” market, coupled with their sky-high tuition costs, alarming drop-out rates, poor job placement services and the many other bad practices, the time has come to discourage funding these enterprises by removing the bankruptcy discharge exception for these types of student loans.

If student loans used to fund for-profit colleges become dischargeable, the money investors put into that industry would dry up, which is a good thing.

The government can garnish 15 percent of disposable pay to collect a defaulted student loan. They do not need a court judgment to do so. “Disposable pay” means the amount of money left in your paycheck after amounts required by law, like taxes, come out. However, you are always guaranteed to be left with an amount per week that is 30 times the federal minimum wage, which is now $7.25 per hour. If you have other debt troubles and are getting garnished for other debts, the maximum total amount that can be taken from you is 25 percent of your disposable income.

Being subject to a student loan garnishment is tough, but there are strategies for dealing with it. One option is to rehabilitation the loan by arranging to make payments. Another option is to consolidate out of the defaulted loan. Some people even file Chapter 13 bankruptcy cases to stop the garnishment and get a three to five year reprieve from their student loan problems, though this only makes sense if one has other debt problems.

Student loan are the next wave of defaults in this country, as I wrote about here.

I discuss financial problems with people everyday.  I usually ask people to give me a little history–how did they get to the point of needing to discuss bankruptcy?  Some of the answers wouldn’t surprise you–job loss, medical bills, divorce.  But it might surprise you how frequently I hear a story that involves financial help to adult children, that ultimately leads to bankruptcy.

Parents struggle with saying “no” to their children almost from day one.  How long do you let your baby cry in her crib before you pick her up?  How long do you linger at the preschool door when your toddler is crying “don’t leave, Mommy.”  From toys to treats to clothes and shoes, we go on trying to strike the right balance, between giving enough and spoiling them rotten. It isn’t easy.  In my own household, every time I say “no,” it is an invitation to a negotiation, and my daughter is a really tough negotiator.  Seriously, union bosses should be so persistent.  And it only gets harder as they get older, and the decisions are about cars and college, student loans and first homes.

So how do you know how much financial help to grown children is too much? That depends on many factors, including how much retirement savings you have, and whether you are considering a gift (or a loan you know won’t actually be paid back), a loan, financing for your child, or co-signing a loan.  Whatever the circumstances, though, you should approach that decision the same way you would (or should) approach taking out a loan, or refinancing your mortgage.  What is your child’s history with credit?  Are you helping a child stretch her wings for the first time, or rescuing a child who has gotten in trouble with credit before?  Are you seeing signs of change, of responsibility undertaken, or are you just reflexively running to the rescue of a child who is in perpetual need of rescue?

I once represented a woman whose house was in foreclosure.  A Chapter 13 case can usually help with that, but this woman was in her 80s, and I was concerned about the feasibility of a five-year payment plan for someone in her situation.   It turned out that she was supporting several grown children who lived with her, and was trying to save the home so they would have a place to live.  But the mortgage on the house was far in excess of the property value.  So I asked her what did she think would happen to the house when she was no longer around to make the payments.  From her reaction, it was apparent that the question had never occurred to her before.

Sometimes the kindest thing we can do for our children is to say “no.”  And while most parents have the instinctive need to help, to try to fix things, the greatest gift we give our children is to teach them to fix it themselves.  Offer a hand up, but not a handout; give them enough help to set them straight, but not so much that they fail to launch.  I know, it’s a hard balance to strike.  Sometimes you miss the mark, miscalculate, and need a bankruptcy to set yourself straight.  It happens. Sometimes it’s the kids who need to file bankruptcy, make a fresh start, and leave you with the ability to help in a real crisis, without exhausting your resources to cover everyday expenses.

Attorneys from the Department of Justicethe Department of Justice presented a program on student loan debt.

The presenters were government attorneys who fight discharge of student loans in bankruptcy cases, but, they presented lots of information on other ways to deal with repayment.

Contact the ombudsman! was a recurrent theme.

The Federal Student Aid Office has an office to clarify student loan deferment, forbearance, and even discharge options, identify your loan repayment options, resolve discrepancies over payments made and balances owed on loans,  among other things.

The government actually says that, if you die, you do not have to pay back student loan debt, but, you do have to file some forms.

“Which loan program am I in?” may well be your first question.

You have to know exactly which program before you can figure out your options.

Higher Education Act, Federal Family Education Loan Program, Federally Insured Student Loan Program, Stafford loansPerkins loans, William D. Ford direct loans, PLUS loans and more.

Strangely, student loan deferment or forbearance are only available for loans NOT in default.

Your loan can be rehabilitated, or re-financing or consolidated, if you do default, which brings the loan back out of default status.

So, if at all possible, if you can’t pay your loan, best to figure that out before you fall behind on the payments.

This is too much to ask of most of my clients.

Forbearance is a  modification of the payment terms, also temporary.

Deferment is a suspension of your obligation, nothing goes away, but your payments stop for a time.

For deferments for government subsidized Stafford loans,  as an example of the differences in how different loan programs are treated:  the government pays the interest that accrues during the time of the deferment.

Qualifications, information required to be submitted, time periods, deadlines, all vary according to which program, or programs, you are in.

So, before you miss a payment, as the government lawyer says, contact the ombudsman!

The Modern Rules Of Student Loan Deferment

The Income-Based Repayment Plan (“IBR”) for student loans is designed to be a better plan than the older Income-Contingent Repayment Plan (“ICR”). Here are some details:

* The IBR applies to Direct Loans and government-guaranteed FFEL student loans.
* You cannot be in default and enter the IBR, but after you get out of default, you can enter the IBR.
* You must be eligible for the IBR. What is required is “Partial Financial Hardship.” You can read more about the formula for determining eligibility for student loan income-based repayment here, but the basics are that there is a minimum income requirements to enter the IBC. Your required payment can be zero, but it is based on your income level and family size.
* Debt Forgiveness: After 25 years in the IBR, your student loan debt is forgiven. However, the forgiven amount is taxable to you unless you qualify for an exception like the insolvency exception.

To gain entry to the IBC you should request an application from your student loan servicer.

It’s no secret that federal bankruptcy courts are reluctant to grant a bankruptcy discharge of student loans based on section 523(a)(8)’s “undue hardship” standard.  Indeed, courts have usually construed the phrase “undue hardship” narrowly, rendering it difficult to discharge student loans in bankruptcy.  However, in a recent Ohio case, the court went to unusual lengths in finding that the repayment of student loans would not create an undue hardship for the bankruptcy debtor.

The debtor in this case, Wallace v. Educational Credit Management Corp., 2010 WL 5764771 (Bky.S.D. Ohio Dec. 1, 2010), had been diagnosed with diabetes at age nine.  In 2004 he obtained a bachelor’s degree in sociology, incurring student loan debt of $32,500 in doing so.  He worked for one year after graduation, earning about $12,000.  However, his diabetes caused him to gradually become blind and was forced to leave the workforce.

The debtor’s diabetes also caused him to require dialysis and even kidney and pancreas transplants.  By 2008 he had a prosthetic right eye, was deemed legally blind, and was awarded social security disability in the amount of $811 per month.  He had not been employed since the year he left college.  He lived with his father and listed expenses of $790 per month in his chapter 7 petition.  Interest of 2.875% had cause the student loan balance to increase to $38,000.

The bankruptcy court began by observing that the “Brunner” test would be applied in determining whether the student loans were an undue hardship.  This test could be met only if the debtor could show the following:

(1) That the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for [himself] and [his] dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a signicant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the student loans.

The court held that the first prong of the Brunner test had been met, but it faltered when it came to the second prong.  The court noted that the debtor had a college degree and that “his physical condition appears to have stabilized.”  Without apparent irony, the court stated that with regard to this blind debtor, “it remains to be seen … whether he will find work or remain unemployed.”  [Italics supplied.]   This meant it was possible that the debtor might someday be able to make payments, and therefore the second prong of the Brunner test had not been satisfied.

The court recognized that was reaching a harsh result, and accordingly it declined to issue a final order of nondischargeability.  Instead, it scheduled a status conference for two years hence, at which time it could be determined whether the debtor’s employment had changed.  In the meantime, the court ordered the debtor to pay $20 per month toward his $38,000 student loan obligations

Student loan debt is not dischargeable in bankruptcy. That’s not news–it’s pretty much common knowledge.  But student loan debt for newly-minted lawyers is a growing problem, since the job market for lawyers is, well, abysmal would be an optimistic assessment.

[A] generation of J.D.’s face the grimmest job market in decades. Since 2008, some 15,000 attorney and legal-staff jobs at large firms have vanished, according to a Northwestern Law study. Associates have been laid off, partners nudged out the door and recruitment programs have been scaled back or eliminated.And with corporations scrutinizing their legal expenses as never before, more entry-level legal work is now outsourced to contract temporary employees, both in the United States and in countries like India. It’s common to hear lawyers fret about the sort of tectonic shift that crushed the domestic steel industry decades ago.

You would think that lawyers would do a better job of taking care of their own.  After all, law schools make a big deal about their job placement services, and the number of graduates who have jobs.  But, since law schools are often profit centers for universities (or for-profit institutions), law schools are in the business of selling themselves, even if they have to fudge the numbers to do so.

The surveys themselves have a built-in bias. As many deans acknowledge, the results are skewed because graduates with high-paying jobs are more likely to respond than people earning $9 an hour at Radio Shack. (Those who don’t respond are basically invisible, aside from reducing the overall response rate of the survey.)

Certain definitions in the surveys seem open to abuse. A person is employed after nine months, for instance, if he or she is working on Feb. 15. This is the most competitive category — it counts for about one-seventh of the U.S. News ranking — and in the upper echelons, it’s not unusual to see claims of 99 percent and, in a handful of cases, 100 percent employment rates at nine months.

A number of law schools hire their own graduates, some in hourly temp jobs that, as it turns out, coincide with the magical date. Last year, for instance, Georgetown Law sent an e-mail to alums who were “still seeking employment.” It announced three newly created jobs in admissions, paying $20 an hour. The jobs just happened to start on Feb. 1 and lasted six weeks.

Does this business model ring a bell with anyone?  Young borrowers seduced by promises of a life of ease and prestige borrow more than they can possibly repay.  And where do you go to find a 22-year-old skeptic, who can grasp the reality of a six-figure debt load?  Here’s the view from one such, Elie Mystal, eight years later:

I graduated from law school eight years ago, and I still don’t answer my phone unless I know who is calling. Every six to eight months, I call up the debt collection agencies that have been hounding me, and do a gut wrenching dance where I try to give them a little more money towards debts that I’ll need to hit the lottery to ever pay off, while they ask for dollar amounts I simply don’t have. At the end of the day, I’m judgment proof. There’s only so much blood you can get out of a rock.And “credit,” I mean, I don’t even know what that is anymore. I’ve been running a straight cash lifestyle since 2003. No really, I haven’t had a credit card since ‘03, even my debit card isn’t a credit card. If I had hit the Mega Millions last week, it’d still be seven year before I saw a 700 on my credit report. People say “Elie, you know you’ll never be able to own a home or finance a car if your credit is that bad.” And I laugh. “Own”? Are you kidding me? Getting a landlord to accept my application to rent is an effort of futility. I once got passed over on a rental for a guy who had just been released from prison.

Mystal asks a couple of  very good questions:  First, where is the consumer protection for these kids? “But, bottom-line, if you sell a toaster that explodes 50% of the time, the government won’t let you sell that toaster. Maybe the ABA doesn’t have the teeth to do it, but somebody needs to regulate law schools. How many lawyers need to be in the room before they start making up some laws?” And then there is this:

The biggest argument in favor of preventing student debt from being discharged through bankruptcy is that it makes banks willing to loan the money. Well, maybe they shouldn’t? Maybe you should have to get an educational loan the same way you get a loan for a small business. Maybe you should have to sit down with a banker and explain to them how you are going to pay them back before they give you money. 150 LSAT score and acceptance to a third tier law school with questionable employment statistics? Sorry kid, nobody is going to give you money for that, for your own good.

The basic public policy justification for bankruptcy is that it is not healthy for all of us for some of us to be enslaved by debt. There is an entire generation of law school grads for whom that is a reality, and it should be chilling for the rest of us.  And I am sure law school grads are not the only one affected–I just happen to be more familiar with the legal profession.  The time has come to reassess the reasons for non-dischargeability of student loan debt, before we completely waste an entire generation of smart young lawyers.  And other professionals as well.

On more than one occasion, I have represented individuals in Chapter 7 and Chapter 13 bankruptcy cases when the debt that prompted the filing was wholly or in large part co-signed debt.   It seems that underwriting standards for most large loans have become tighter and nowhere is this more true than in the case of student loans.

From the lender’s perspective, student loans can pose a significant risk.  Unlike mortgages, there is no collateral to secure the loan.  The borrower, of course, is a student who may or may not find suitable employment.   Given that college and trade school loans can easily top $100,000, the likelihood of slow pays or defaults is high.

I am also seeing more and more cases involving student loans from so-called “for profit” colleges – usually vocational schools.  According to the United States Department of Education, 34 million borrowers owe $713 billion, with $50 billion of these funds in default as of September 30, 2010.

Student loan debts are not dischargeable in a bankruptcy unless the debtor/borrower can show extreme hardship, which is a very hard result to accomplish.  In the Northern District of Georgia, where I practice, a debtor generally must show compelling evidence – usually in the form of a chronic medical problem – that would prevent repayment of the student loan, and the judges here have been very reluctant to grant this type of relief.

I am also seeing more cases where the student loan lender is demanding a co-signer, usually a parent, but possibly grandparents or siblings.  What happens when tragedy strikes and the primary borrower (the student) dies before he is able to pay back his loans?

If the loan is federally backed, (Stafford loans or PLUS loans), the student loan is discharged if the primary borrower (the student) passes away.  If the loan is private, the death of the primary borrower does not relieve the co-signer from his or her obligation to pay.   Since the rigorous “hardship discharge” standard applies to both federally backed and private student loans, a surviving parent or grandparent may be left with a lot of non-dischargeable debt.

Below poverty level income for five of the past six years was no basis for discharging a chapter 7 debtor’s student loans, where she was voluntarily underemployed, had no dependents, and lived with her boyfriend, relying on his income as if they were married, according to the Bankruptcy Appellate Panel for the Eighth Circuit.

The debtor in Sederlund v. Educational Credit Management Corp., 2010 WL 4273243 (8th Cir. BAP Nov. 1, 2010), was a 42 year old college graduate who had obtained her degree in psychology, but had never worked in that field.  She graduated in 1992 owing $16,649.70 in student loan debt.  She paid $11,825.10 toward the student loans over the next twelve years, but was later granted deferrals on the payments.  At the time of her chapter 7 filing in 2008, she owed approximately $47,000.00 on her consolidated student loans.

In the years leading up to the case, the debtor’s income had been minimal: in 2004, it amounted to $6,601; in 2005, $5,930; in 2006, $9,180; in 2007, $5,316; in 2008, $12,635; and in 2009, $6,506.  All these figures except that for 2008 fell below the federal poverty level for annual income.  The debtor had typically worked as a secretary for law firms and had an inconsistent employment history, working most recently at a catering company.

The court noted that the debtor had either quit some jobs, or had been fired from others, for reasons for which she was at least partly to blame.  She quit one job after arguing with her boss; she quit another because she disliked her supervisors’ abusive attitudes; she quit another due to arguments with coworkers; she was fired from another job after having a dispute with a coworker over work hours. The debtor was currently working in food service, but despite having a low number of weekly work hours, she testified she was not seeking a better paying office job.

The court found that the debtor’s “undue hardship” claim failed because she had simply quit jobs she did not like, and that she had lost jobs due to complaining too much.

The court also found that her boyfriend’s income should be imputed to the debtor, because they lived together and their relationship was no more stable, nor was it less stable, than that of typical married couples.

Finally, the court noted that under an income contingent repayment plan (ICRP), the debtor’s monthly student loan payments would be zero.  She had not applied for the ICRP due to her belief that there would be negative tax consequences to her if the student loans were forgiven.  However, the court rejected this argument and held that tax consequences could not form a basis for a finding of undue hardship.  It therefore affirmed the lower court’s nondischargeability ruling.