Student Loan Default

Debtors often ask the question whether student loan debt is dischargeable in bankruptcy. Student loans can be consolidated with your other bills in a Chapter 13 court-ordered repayment plan. During a Chapter 13, the student loan agency must accept payments under the terms of the Chapter 13, just like all of your other creditors. The student loan agency cannot pursue you for any unpaid portion of the student loan during the Chapter 13. After your Chapter 13 discharge, however, the student loan agency may pursue you for any portion of the student loan that was not satisfied by your Chapter 13 payment plan. So, the Chapter 13 will give you temporary relief, allowing you to pay a reduced percentage of your student loan and other outstanding obligations. When the Chapter 13 is discharged or dismissed, however, you will still have to work out a payment plan with the student loan agency.

Generally, student loans are not discharged in a Chapter 7 bankruptcy case. Presently, the only ground for discharge under the bankruptcy code is that the repayment of the loan "will impose an undue hardship on the debtor and the debtor's dependents." Unfortunately, it is extremely difficult and rare to meet the criteria for an "undue hardship" discharge.

There are, however, several options to help borrowers with defaulted student loans:

I. Loan Cancellation:

These types of federal remedies are available to the borrower even if the student loan is not in default. Keep in mind, however, that not all types of loans are eligible for cancellation. To find out what type of loan you have, contact the National Student Loan Data System at 1-800-4-FED-AID, or online at www.nslds.ed.gov.

The following are the main federal programs for student loan cancellation: Forms can be downloaded from (http://www.ed.gov/).

A. Closed School: Applies to Direct Loans, Perkins Loans and FFELs. Students must have been enrolled in school at the time of closure. If the student withdrew, the withdrawal had to occur within 90 days of the closure. (http://www.ed.gov/.)

B. False Certification: Applies to FFELs and Direct Loans, but not Perkins Loans. To qualify, the student must show that he/she was not able to meet eligible state requirements for the job he/she was training for, or that the school altered or forged loan or check documents. This type of discharge applies only to loans received on or after January 1, 1986.

C. Total and Permanent Disability: This type of discharge applies to FFELs, Direct Loan and Perkins Loan. The borrower must be found totally and completely disabled to be eligible for this type of discharge, and must provide documentation from a physician that they are unable to work because of an illness or injury that is expected to continue indefinitely or result in death. This type of discharge is not available to the borrower if the condition existed at the time the loan was made. However, under new rules, pre-existing conditions may qualify if the borrower suffered substantial deterioration after the loan was granted.

D. Unpaid Refund Discharge: As part of the 1998 Higher Education Act, this discharge will allow students who borrowed after January 1, 1986, to discharge the amount of the loan to the extent of the amount of refund owed to the student which the school failed to reimburse. Included in this discharge are reimbursements of tax refunds seized by the IRS in repayment of the student loan debt to the extent of a refund the school owed the borrower but never paid.

II. Repayment Options:

Even if the borrower does not qualify for a federal discharge, there are still some strategies to explore in dealing with defaulted student loans.

A. Loan Consolidation: This program allows those who do not qualify for a federal discharge to consolidate their defaulted loans into a Federal Direct Consolidation Loan with an Income Contingent Repayment Plan (http://www.ed.gov/directloan).

B. Deferments and Forbearances: Borrowers may qualify for either a deferment or forbearance even if the loan is in default. The main types of deferments are: student deferments; unemployment deferments, and economic hardship deferments. However, keep in mind that deferments may not exceed a three year time period. Forbearances are available even when the loan is in default, but the interest continues to accrue during the forbearance period.

III. Offset of Federal Benefits:

Finally, borrowers whose student loans are in default often inquire as to whether their Social Security Benefits can be taken by the government in repayment of defaulted student loans. Under the 1996 law, the federal government can take benefits from Social Security Retirement and Disability Benefits, Certain Railroad Retirement Benefits, and Black Lung Part B Benefits. However, keep in mind that there are limits on the funds that the government can take, and that the borrower can fight back. You must receive notice of a hearing before any of your benefits are taken.
If you owe on a defaulted student loan, your hearing will be with the Department of Education. At the hearing, you can either challenge the offset, or set up a repayment plan prior to having your benefits seized.

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