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Department of Education Reaches Decision About Student Loans and Bankruptcy

By on July 7, 2015

The Department of Education has just released guidance on how it will handle bankruptcy discharge requests for government backed student loan debt. And while the guidance is helpful, it’s also a bit disingenuous that it places the burden on students who believed what schools and colleges sold them as a smart financial move.

The guidance wants to provide a balance between collecting on student loans except where the loans would pose an undue hardship on the debtor.

The Department of Education desires to find its balance in collecting debts versus allow debt to be discharged. What this formula misses is the inequity of the indebtedness to begin with by schools, for-profit and nonprofit, pushing loans on consumers. It’s almost like a game of “tag, you’re it” where the consumer is the one holding the bag or hot potato.

But the July 7, 2015 letter from the Department of Education gives some hope to those seeking discharge of some student loan debt. The United States Department of Education says, it would consent to and/or not oppose undue hardship discharge of student loans where repaying the loan would impose an undue hardship on the debtor. – Source

Attorneys have been vigorous to challenge consumers who have sought to discharge their federal student loan debt even when it has been an undue hardship. But the guidance released today also let’s us know that challenging these cases has a formula for when it is NOT advantageous for the government to oppose the discharge request. The document from the Department of Education says, “If a holder determines that requiring repayment would not impose an undue hardship, the holder must then evaluate the cost of undue hardship litigation. If the costs to pursue the matter in bankruptcy court are estimated to exceed one-third of the total amount owed on the loan (including the current principal balance, any unpaid accrued interest, and current, unpaid accrued collection costs), the holder may accept and/or not oppose an undue hardship claim by the borrower in an adversary proceeding.”

It’s too early to see how many lenders “may” elect to follow this advice. But having this in writing is a good tool for consumer bankruptcy attorneys.

Undue Hardship Formula

Here is what the Department of Education has to say about what constitutes and undue hardship and thus a consent to allow the student loan debt to be discharged.

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The following factors and considerations are offered as points to consider by lenders for discharge:

  • Whether a debtor has filed for bankruptcy due to factors beyond his or her control and the impact such factor(s) have on debtor’s ability to repay the student loan debt. Which includes a divorce resulting in diminution of family income, which will not realistically be reestablished.
  • Whether a debtor who asserts undue hardship due to physical or mental impairment may qualify for Total and Permanent Disability Discharge (TPD) and/or other administrative discharges available. These include:
    Death Discharge
    Closed School Discharge
    False Certification Discharge
    False Certification Ability to Benefit
    Unauthorized Signature or Identity Theft
    Unpaid Refund Discharge
    Borrower Defense
  • Veterans who have been determined by the Department of Veterans Affairs to be unemployable due to a service-connected disability.
  • Whether a debtor is approaching retirement, taking into consideration debtor’s age at the time student loans were incurred, and resources likely to be available to the debtor in retirement to repay the student loan debt. Borrowers who choose to incur student loan debt at an older age, whether that debt is for themselves or a dependent (i.e,, Parent PLUS loans), should not be able to rely on their age alone and/or their entrance into retirement to prove undue hardship.
  • Whether a debtor’s health has materially changed since the student loan debt was incurred.
  • Whether significant time has elapsed since the debt was incurred.
  • Whether a debtor’s expenses are reasonable and indicate minimization of unnecessary expenses to provide funds for student loan repayment.
  • Whether a debtor had the mental and/or physical capacity to pursue administrative discharge options and/or income-driven repayment plans, if those options were not pursued, or whether a debtor had any physical or psychological factors that would have made the administrative process more burdensome to the borrower.

Here is an actual example of when the Department of Education feels bankruptcy discharge should be considered.

Facts: Borrower obtains student loans in order to complete a Master’s degree. Upon graduation she starts working and making payments. A few years after her graduation, her child becomes seriously ill, with no prospect of recovery, requiring round-the-clock care. The child’s illness is followed by a divorce, with no child support or alimony forthcoming. This set of circumstances makes the borrower unable to work full-time due to child care obligations. She works part-time, bringing in only a fraction of her full-time income. Her child’s medical expenses are also extremely high.

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Analysis: The facts above show that debtor demonstrated willingness to repay her loans and did so when her resources permitted, and that her bankruptcy filing and circumstances were a result of circumstances beyond her control. Furthermore, the circumstances that caused her financial difficulties are likely to persist. The Department believes that a pattern such as this would warrant exploring some of the income-driven repayment options. If these options are not available and/or do not alleviate the financial hardship, a consent to undue hardship discharge, either in full or part, may be appropriate.

Bottom line, if the consumer and bankruptcy attorney put forward a reasonable and well documented case the student loans will create an undue hardship, the guidance offered today by the Department of Education is “If this consideration leads to the conclusion that repayment would impose an undue hardship, the holder should consent to, or not oppose the discharge, as authorized by the governing statute and regulations.”

What Now?

While the Department of Education has laid out a course more bankruptcy attorneys can follow to seek a discharge of student loan debt as an undue hardship, it will take time for a smooth process to be developed. But even if the government does not allow for a total discharge of the debt, there exists an opportunity to “agree to discharge of a portion of the amount owed” and allow the consumer to get a bit of a bankruptcy fresh start.


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About Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

9 Comments

  1. Ezo

    January 24, 2017 at 11:49 pm

    I was admitted to a US accredited medical school (MD) & failed M1. I failed every. single. course. The school allowed me to continue all the way through M1 though (?!) which meant paying for the second semester in full using federal student aid. That institution failed me. If I failed every course the first semester… I feel like that medical school should not have been allowed to accept payment via direct payment from a federal student loan (they would refund a certain amount to the medical students after all required tuition & fees for that semester were fully covered, a very small amount to be used for living expenses). I am not wealthy nor do I come from a wealthy family. My families household income was under 20,000 growing up. I graduated from a highly competitive undergraduate university ~ 45k annual tuition with only ~ 5k in student debt total thanks to a ton of financial aid & scholarship. Then: M1, I fail out of medical school. Why did I stay an entire year? With the stress & financial bind I was in, I wasn’t thinking clearly. I spent an entire year living well below the poverty level (again, I do not have a wealthy family. That extremely small refund was all I had). Now, I am angry, realize it was completely irresponsible of me to allow them to let me rack up a 50,00 student loan debt when I did not even pass the first class of the first semester. I don’t think the fault lies with the department of education on this one, but the medical school, or more likely the University it is affiliated with. What can I do?

    • Steve Rhode

      January 25, 2017 at 10:21 am

      While you might have an argument to make against the school I doubt you would be able to afford the risk of taking on the financial burden for filing such a case. Other cases filed against law schools for education malpractice, failed.

      You might want to begin the hunt now for attorneys who take on student loan debt in bankruptcy and/or get those loans on an income-driven repayment plan to keep you out of default.

  2. wanda

    August 5, 2015 at 2:18 am

    How much time lapse is considered “significant” for the court to possibly discharge a student loan?

  3. Steve Rhode

    July 24, 2015 at 1:08 pm

    There is no such listing, yet. You’ll have to talk to local bankruptcy attorneys who have experience dealing with these issues. Fighting the battle yourself in bankruptcy court can be daunting. But here is one example of a couple that has made substantial progress in doing it themselves. See https://getoutofdebt.org/92369/bankruptcy-court-wants-to-discharge-spousal-consolidation-student-loans-educational-credit-management-corporation-says-not-so-fast

  4. Anon Person

    July 9, 2015 at 3:49 pm

    Thanks Steve… I downloaded and saved the DOE update! Sounds like they are waking up to the reality?

    • Steve Rhode

      July 13, 2015 at 11:00 am

      I sense a rocky rollout. The new guidance says they “may” allow the discharge and in time it will become a standard. But till the individual servicers get their processes worked out it may be a bit uneven in implementation. However it is very nice to have this written documentation to add some clarity to federal student loan discharge in bankruptcy.

  5. Anon Person

    July 8, 2015 at 8:09 pm

    Where is the original letter described in the article you wrote about the Dept of Ed and bankruptcy ?

    • Steve Rhode

      July 9, 2015 at 3:10 pm

      Click on the source link in the story.

  6. Neil Ackerman

    July 8, 2015 at 6:47 pm

    Nice post, Steve.

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