I thought all student loans could not be discharged in bankruptcy?

There is a common misunderstanding that all student loans are not dischargeable in bankruptcy.  All student loans, however, are not created equal.  Many, in fact, are dischargeable.

The source of this misunderstanding is a cryptically worded section of the bankruptcy code: Section 523(a)(8).  The cause of its cryptic wording is its historical evolution. At one time, it was easy to read and understand, but over the years, Congress added bits and pieces making the whole of it barely comprehensible.

Let’s look as the section as it exists today:

 “(a) A discharge under [the bankruptcy code] does not discharge an individual debtor from any debt—

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

(A)(i) 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

 (ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

 (B) 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;”

See what I mean?  You have to read it five times, and even then it’s not clear.  The first thing you notice is the word “unless.”  It just doesn’t seem to fit in or flow smoothly.  This is because that phrase used to come after the part that describes the different kinds of educational debts.  Prior to 2005, the section was worded like this:

 “(a) A discharge under [the bankruptcy code] does not discharge an individual debtor from any debt—
. . .
for 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 for an obligation to repay funds received as an educational benefit, scholarship, or stipend unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents.”

 See the difference?  It read much more clearly in 2005 before Congress flipped the “unless” clause.  But the gist is the same, although it takes a while to figure it out.  It sets up a double-negative (“does not discharge . . . unless . . .” ).  It also creates a kind of juxtaposition of the “discharge” concept with the different kinds of educational debts.  In other words, there is presumption that all debts are discharged in bankruptcy unless they are excluded from discharge; and the only forms of educational debts that are excluded are the ones specifically enumerated.

Which brings us to the next observation:  in the current version of the statute, there are four distinct types of educational debts described.  First, there is an “educational benefit overpayment.”  That’s not a loan at all.  Secondly, there are “guaranteed loans.”  Thirdly, there is an “obligation to repay” funds received as an educational benefit, scholarship or stipend.  Fourthly, there are “qualified education loans.” Each of these are distinctly different from one another, and your loan must scrutinized carefully to determine whether it fits into one of the categories or not.

Let’s look at them individually.

An “educational benefit overpayment.”

This is not a “student loan” at all.  This happens when you are awarded a scholarship or grant and the agency simply pays you too much.  It might not be obvious to you at the time, because the financial aid agency might apply the funds directly to tuition, so you never actually see the money in your hands. Or, they may pay you a few extra months of work-study, which you simply did not notice.  In complicated scenarios, the financial aid agency may actually award you too much financial aid, pushing you over the eligibility limit for qualified loans, and making the loan disqualifying for you and for the school.  In those case, they may demand that it be paid back to bring the school back into compliance. These are highly uncommon situations.

Guaranteed Student Loans.

In the past, most student loans were provided by private lenders, like your local bank, but were “guaranteed” by a government agency.  The “guarantee” means that the government agency will reimburse your local bank if you default, and then the federal government would pursue you to collect the loan.   There were many different federal agencies which guaranteed student loans.  Each agency supported a different career path to enhance its mission, like the U.S. Department of Health and Human Services, the National Health Services Corps., or even the Air National Guard.  Most states also developed state agencies making that guaranty, and those state agencies were, in turn, insured by the federal government.  There are now about 35 different state agencies guarantying student loans, such as the Florida Department of Education and the New York State Higher Education Services Corporation.  In some cases, several states have banded together to form a nonprofit agency to service several states, such as the United Student Aid Funds, serving eight states.  These were called Federal Family Education Loans (FFELs).

In 1993, the federal government began providing loans directly to students under the Direct Student Loan (DSL) program.  In 2010, FFELs were discontinued in favor of direct loans, but many people are still repaying guaranteed student loans taken out before July, 2010.

So FFEL’s are generally loans issued by private lenders but insured by a government agency; and DSL’s were loans actually made directly by the federal government.

The most commonly known guaranteed student loans in this category are Stafford loans, Perkins Loans, PLUS loans, PARENT PLUS loans, SLS loans, National Defense Student Loans, Federal Insured Student Loans (FISL’s), Guaranteed Student Loans (GSL’s), National Direct Student Loans, or consolidation loans.

Stafford loans are the most common of this category.  They have been around since the 1960’s.  They are “subsidized” loans; i.e., the student does not have to pay any interest on the loan while in school, or during a grace period after graduation.

Perkins loans are intended for students with very low incomes. The federal government guarantees repayment of Perkins loans but, unlike most other loans, Perkins loans are made by the school with a combination of federal and school funds. This means that the school, not a bank or the government, is the lender.

There are other types of student loans, especially for specialized programs such as nursing students. You can read more about the various programs here:  http://studentaid.ed.gov.

The big picture here is that loans in this category must be either (1) made directly by the government, or (2) made by a private lender and guaranteed by the government; or (3) made by a non-profit institution and guaranteed by the government.

If your Perkins loan was from a traditional non-profit college or university, it probably fits in here.  But if your loan was from a for-profit school, it may be dischargeable.  Don’t assume your school was a non-profit institution.  There are many for-profit colleges and universities.  See a list here:  http://en.wikipedia.org/wiki/List_of_for-profit_universities_and_colleges.  And, there are lots and lots of schools which are not traditional colleges which are for-profit, such as vocational or trade schools.  If you went to an Embalming Institute or Court Reporter Academy, these are the kinds of schools which are typically for-profit.

An “obligation to repay” funds.

An “obligation to repay” is not the same thing as a loan obligation.  They mean different things.  When Congress added the “obligation to repay” clause, section (a)(8) already had a loan obligation clause, so they must have intended something different than guaranteed student loans.  What they meant was programs where the government would pay a portion of a student’s tuition in exchange for an agreement to work in an economically depressed area for several years.  If the student does so, there is no obligation to repay the tuition.  But if the student does not fulfill that commitment, an obligation to repay the tuition arises.  Remember Dr. Joel Fleischman on the 70’s television show “Northern Exposure?”  He often lamented about being stuck in Alaska, otherwise he’d have to repay his huge medical school tuition paid by the government.  These are also highly uncommon situations.

“Qualified education loans”

The IRS got into the student loan business because parents want to deduct tuition and loan payments they make for their children on their tax returns.  And Congress wanted to encourage such spending, thus providing tax breaks, including valuable education credits.  In order to make the system work, the IRS had to create complicated rules to determine which programs qualify for the tax benefits.

In order to be a “qualified” education loan under the Internal Revenue Code, the loan must meet at least three strict conditions:  (1) it must be made to a taxpayer; and (2) it must be made for “qualified education expenses” at (3) “an eligible educational institution.”

So if you are not a U.S. taxpayer, your loan is dischargeable.  Many foreign students fit into this category.  Beware, however, that even if you were a foreign citizen, if you worked in the U.S. while attending college or grad school, and had taxes withheld or had to file a tax return, you became a taxpayer.  In In re LeBlanc, 404 B.R. 793 (Bankr. D. Penn. 2009) the student was a Canadian citizen studying in the U.S. but never became a “taxpayer” and thus her student loans were not “qualifying” education loans.  The court found over $300,000 in student loans were dischargeable.

And “qualified education expenses” is another hurdle.  The federal regulations require the loan money be used solely for higher education expenses, i.e., tuition, dorms, books, academic fees, etc.  Many students used their loan money to pay off credit cards, or prior loans, or to pay sports fees, sport training camps, sports equipment, or a semester abroad. If you used  your student loan funds to pay for these kinds of things, that loan may be dischargeable in bankruptcy.

Another sub-set of “qualified education expenses” requires that your loan be within certain limits.  If you exceed your eligible private loan cap, loans made after that time are not considered “qualified education expenses” by the IRS.  Most prudent colleges and universities have financial aid departments which keep careful track of this, but many private lenders do not.  And, schools do not always have records of loans you obtained elsewhere, such as from an earlier school or an outside private lender.  So this area deserves careful scrutiny to determine if your loan may be dischargeable.

Finanlly, to be a “qualified education loan” it must have been for attendance at an “eligible educational institution.”   Most traditional colleges and universities are “Title IV” institutions, that is, a qualified participant in federal financial aid programs. But if you went to a for-profit college, or non-traditional kind of education program, these should be checked out.  Look carefully at truck driving schools, hairdressing schools, flight schools, etc. 

Here are some common examples of when a student loan may not be a “qualified education loan:”

  • The money was not used solely for higher education expenses, i.e., some of it was used to pay off credit cards or a home equity loan. Or, you borrowed $25,000 and used $5,000 for tuition and the rest to live on.
  • The debt was not incurred by the student, student’s spouse, or dependent. If a kind uncle takes out the loan for you, it may be dischargeable.
  • The debt was not incurred by an individual, i.e., your father’s company took out the loan;
  • The loan was made while you were not an “eligible student.” If you were not carrying at least a half-course load, or were studying abroad, or doing home study, or you were otherwise not an eligible full-time student, the loan is dischargeable.
  • The school was not a traditional Title IV institution, such as truck driving schools, vocational schools, hairdressing schools, flight schools, etc.
  • The loan was made for expenses that exceeded the “expected family contribution” limit.
  • The money was used for study abroad at an institution that was not approved by the home institution.
  • The money was used for the purchase or rental of equipment, supplies or material that are not required by your course of study by your college. A kayak may be required by a physical education major, but is not likely to be required for a theater major.  A computer, also, may not be required unless it’s a listed qualified adjustment to cost of attendance by your school.
  • The money was used to pay a previous term’s bills.
  • The loan was not from a traditional education loan source. In In re Reis, 274 B.R. 46 (Bankr. D. Mass. 2002) the grandparents lent their grandchild money for college, and this was found dischargeable since it was not an IRS “qualified” education loan.

Conclusion

Still think all student loans are not dischargeable in bankruptcy?

Still think student loans can only be discharged in the case of hardship?

You should scour your records to find all original student loan documents, all financial aid award letters, and all tuition invoices showing cost of attendance and bring them in to your bankruptcy attorney for a careful analysis.  There is a good chance one or more of your student loans are dischargeable in bankruptcy.

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