Stuck With Unaffordable Student Loans, Now What?


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Every year, millions of students are convinced to take on student loans with promises of huge salaries upon graduation, but often the reality is a bit different and these same students are left with an enormous debt and little or no means of repayment. Indeed, these debts can last for decades.

This issue was raised by a reader of HG.org who asked:

I cannot pay back my student loan I thought the loan was discharged through my chapter 13 bankruptcy [but] it wasn't. However the burden of repaying my loan would impose a severe hardship due to my age. I am 66, and plan to retire next year. My income will be social security and perhaps a part-time job.

She indicated later in her message that these debts date back to the 1980's. Now as she nears retirement and has already had to deal with bankruptcy, she finds herself still straddled with these same obligations.

This is a tricky situation.

Unfortunately, it is true that generally student loans are not discharged by bankruptcy. The very rare exception is when one can show at the time of the bankruptcy that the debt created by the student loans is going to create an unreasonable burden to the debtor and that the debtor will never be able to make payments, often because of a disability or other circumstance beyond the debtor's control. Absent that, the debts to federal student loan companies are exempted from bankruptcy and will not be discharged. If a borrower believes they are in such a situation, they should consult with a bankruptcy attorney who may be able to help them prepare the appropriate pleadings to seek this relief. However, it is important to understand how unusual this kind of relief is, so if a bankruptcy attorney advises that it is not going to be likely or possible, you should probably trust their opinion.

However, there is some possibility for relief. The College Cost Reduction and Access Act, signed into law in 2007, largely became effective in July 2009. The Act contains provisions designed to improve the ability of a borrower to pay off post-education debt. Specifically, there are two plans, one based purely on the financial ability of a borrower to repay and one based on career choice.

The Income-Based Repayment plan provides a number of means of reducing student loan payments to much more affordable levels, even down to nothing under certain circumstances. The debt still exists and the interest still accrues, but if the repayment rate is reduced sufficiently the payment should be less painful (or no pain at all if it reduces to zero) and the debt will ultimately die with the borrower and not be passed to one's beneficiaries. Furthermore, this plan allows for loan forgiveness after either 10 or 25 years depending on one's career choice.

To qualify, the borrower must show at least partial financial hardship in the form of high debt-to-income ratio. Qualifying loans include both Direct and Guaranteed student loans, such as Stafford, GrandPLUS, and consolidation loans. It does not apply to Parent PLUS, Perkins, or private loans. The borrower's monthly loan payment is calculated as 15% of the individual's discretionary income. Discretionary income, in turn, is determined by the difference between the borrower's monthly adjusted gross income and 150% of the federal poverty line, and is recalculated on an annual basis.

After 25 years of repayment under this plan, any remaining debt is forgiven regardless of the borrower's career choice. However, one very important caveat: when the debt is forgiven the IRS will consider it income and it will be taxable. That could really hurt for those with remaining obligations in the tens of thousands range. Indeed, if the borrower has a relatively low amount of discretionary income, resulting in a very low payment, the forgiven balance at the end of 25 years could actually be more than what was owed at the beginning of the repayment period due to the accumulation of interest.

Another variation of this plan is the Income-Contingent Repayment Plan. This variation is for anyone who does not qualify for the Income-Based Repayment Plan, and is available only for Federal Direct Loans and Grad PLUS loans. It is not available for Federal Family Education Loans (FFEL), parent PLUS, or private bank loans. Under this variation, the amount paid each month is the lower of the following two formulas: 20% of the borrower's monthly discretionary income or the amount the borrower would have repaid under a standard 12-year repayment plan multiplied by an income percentage factor determined on the basis of income and marital status.

Just as with the Income-Based Repayment Plan, the Income-Contingent Repayment Plan qualifies for debt forgiveness after 25 years of repayment, regardless of career choice.

The Public Service Loan Forgiveness plan, on the other hand, allows borrowers to opt for careers in government and nonprofit fields while still allowing them to get rid of debt in a reasonable period of time. If the borrower earns less than 150% of the federal poverty level based on family size, that borrower's loan payments will be $0, but they will still count toward the borrower's 120 monthly payments for loan forgiveness. This plan applies to Federal Direct Loan. The borrower's employer must be a government agency, a 501(c)(3) not-for-profit entity, AmeriCorps, or the PeaceCorps. For the debt forgiveness to apply, the borrower must be using one of the above-identified repayment plans and the loans cannot be in default.

In order to qualify for these programs, one can register directly at the federal department of education's website (www.dl.ed.gov).

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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.

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