For many college students, three things are certain about their future: death, taxes, and years of student loan repayment. Student loan repayment is a must whether the student graduates or not. A percentage of those students will default on their student loans because of low income. If an individual couldn’t make student loan payments, should those payments be dismissed because of hardship? The Seventh Circuit of Appeals recently decided on if a graduate should have his student loans dismissed.
Tetzlaff vs. Educational Credit Management Corporation
Petitioner Mark Warren Tetzlaff is seeking to have his student loan debt discharged. Tetzlaff, 56, lives at home with his mother. He owes about $260,000 in student loan debt guaranteed by Educational Credit Management Corporation. In 2012, he filed for Chapter 7 bankruptcy. In his petition, he requested the bankruptcy courts discharge his loans because repaying the money would cause undue hardship for him.
Both the district court and the Seventh Circuit denied his request. In the original denial, the bankruptcy court found Tetzlaff’s financial situation could improve. It cited facts like:
- His MBA
- Being a good writer
- His intelligence
- Temporary family issues
In addition, the Seventh Circuit questioned whether he’d actually made a good faith effort to repay his student loans.
U.S. Bankruptcy Courts Do Allow Hardship Discharge in Chapters 7 & 13
Tetzlaff requested the undue hardship exception afford some debtors in bankruptcy proceeding. The exception does wipe out student loan debt if the debtor can show it would be too hard to make the repayment. There’s a test to determine whether the debtor does have this option. The test varies between bankruptcy courts, but many use either:
- The Brunner Test
- The Totality of the Circumstances Test
The Brunner Test
With Brunner, a debtor’s income is scrutinized. The poverty factor compares the debtor’s current expenses and income to the poverty level. The debtor can’t maintain a minimal standard of himself and dependents if forced to repay student loans. The second factor is persistence. The court looks at the debtor’s current finances and whether it will continue throughout the repayment period. Good faith is the last part of the test. The courts determine whether the debtor has made a good faith effort to repay student loans.
The Totality Test
Some bankruptcy courts use the totality of the circumstances test. This test looks at all the important factors in a debtor’s bankruptcy case to determine if there’s undue hardship or not. The test is more holistic, than the Brunner Test.
According to a US News article published in 2014, about 40 percent of debtors who include their student loans in bankruptcy petitions receive a favorable outcome. The petitions that received a favorable outcome had some or all of their student loan debt discharged through bankruptcy. Although the article reveals some students were able to discharge their loans, it also means that the majority of the debtors seeking student loan discharged weren’t successful.
Student loan debt is dischargeable in bankruptcy, but only under the narrowest of circumstances. This creates a problem for those denied bankruptcy relief for their student loans.
Bankruptcy Provides a Fresh Start
According to bankruptcy laws, chapter 7 or 13 provide a debtor with an opportunity to financially rebuild his or her life after a financial hardship. Whether it’s eliminating unsecured debts or saving a home, a debtor can have a fresh start if the petition is granted. For debtors with non-dischargeable student loan debt, the promise of a fresh start is stale.
The problem is that there is a 60% chance that student loan debt will survive the bankruptcy. This means whatever financial fresh start he or she had in bankruptcy is gone. A debtor faces tough consequences when defaulting on a student loan such as:
- Loans turned over to a collection agency
- Paying additional court costs and attorney fees
- Wage garnishment
- Sued for entire student loan amount
- Federal and state income tax refunds taken to repay student loans
- Student loan default listed on credit history for up to seven years
- Ineligible for deferments
- Ineligible for professional license renewals
- Ineligible for financial aid
- Ineligible to enlist in the U.S. Armed Forces
Potential for Fraud?
Opponents of bankruptcy reform argue that if we make it easier for a debtor to discharge student loans, bankruptcy fraud will rise. Bankruptcy fraud is to delay, defraud, or hinder the bankruptcy court and/ or creditor. Bankruptcy fraud can range from hiding assets to making false statements under oath.
There’s a chance debtors will try to defraud the bankruptcy courts or creditors to have their student loan debts discharged. However, bankruptcy fraud isn’t new. It does happen and debtors are caught. I’m sure if the law is changed, debtors will be more scrutinized before any loan debts are discharged.
Change the Bankruptcy Law to Help More Debtors
It is a moral and binding obligation to repay student loan debt no matter how much money one makes. The government and private lenders provide the loans based on getting money back in the future. It’s the only reason why a young broke college students can get thousands of dollars in cash to attend school. Lenders bank on the young broke college students graduating and making a six-figure income and repaying their six-figure debt.
However, just because a debtor may no longer have to pay loans, doesn’t mean the debtor has no obligations. In many cases, the debtor is already behind in payments and has little to no money to make student loan payments. Whether or not a debtor can afford to repay his student loan shouldn’t be based on the bankruptcy courts’ interpretation of a bright future.
We should change bankruptcy laws to allow people close to defaulting on their student loans the ability to discharge part or all of their student loans in bankruptcy.