With the economy headed south, I am hearing from more and more people who have either lost their jobs or who have been unemployed for a while with little hope of finding employment soon. Some of these folks have outstanding student loans and they are not happy at all when the U.S. Department of Education or other student loan servicer grabs their tax refund to pay all or part of an outstanding student loan.
Unlike other creditors, student loan creditors do no have to sue you and obtain a judgment in order to collect from you. Blog reader Nancy describes a disheartening scenario:
I am dealing with a student loan that’s 25,000.00 and the Department of Education took my tax return from me. I am a single mother with a special needs child and needed every bit of that money. I have been on unemployment since Jan of 08. Things are not looking up for me in finding employment in my area. I am roommateing with a friend just to make ends meat here and I was told that maybe filing for a chapter 7 would be good for me. I have no credit card debt but I do have some hospital bills. Not sure what I need to do, I know that I can not afford this 25,000 student loans which by the way started out only 15,000. Interest has taken over and made it an impossible dept to pay off. Please tell me what I should do. I also cant afford to have my taxes taken away every year from something that will never be paid off due to those interest rates.
Here is my response: As a general rule, bankruptcy is not a good tool to reduce or eliminate student loans. Many years ago, when I first started my bankruptcy practice, you could discharge student loan debt. Over the years, Congress has whittled away that option. Now, not only are student loans protected from bankruptcy discharge – except in very limited situations – but student loan creditors can seize tax returns and garnish wages without first going to court to obtain a judgment. In some respects, student loan debt has almost as much priority as child support or tax debt.
The only possibility for student loan discharge may be found at Section 523(a)(8), which denies a bankruptcy discharge to
– an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
– any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;
unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents
As you can see, therefore, the only mechanism to discharge student loan debt is to claim that not discharging the debt would create an “undue hardship” on the debtor and the debtor’s dependents.
As you might imagine, shortly after Section 523(a)(8) went into effect, a number of debtors filed paperwork in bankruptcy asking judges to discharge their student loans based on this undue hardship language. The result of these attempts has not been positive for debtors. For the most part, judges in the Northern District have been extremely reluctant to permit the discharge of student loan debt. In the few cases where discharge has been granted, the basis for the hardship usually has been medical – i.e., a debtor has a debilitating condition that would preclude any type of substantial work. There have also been a few cases in which judges have partially discharged student loan debt even when it is very much unlikely that the debtor will ever have the financial capacity to pay back his student loan debt.
In my reading of these cases, judges have not been sympathetic to the “I am unemployed and don’t expect to find a job soon” argument. Often the judges look at the debtor’s education, health and potential earning capacity and take the position that at some point in that debtor’s life, he will find a decent job – or at least a job that will allow for repayment of the student loan.
Because bankruptcy is a very limited and unlikely option, student loan creditors are rarely willing to work out any kind of repayment deal. They know that they can garnish wages or seize tax refunds so they have very little incentive to strike a deal.
In Nancy’s case there does seem to be a medical element present – the cost of raising a special needs child, but that argument would need to be developed and reviewed in light of applicable case law. Again, in my view at least, the unemployment argument will not go very far.