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The Student Loan Debt Bomb: America's Next Mortgage Economic Crisis

student-loan-consolidation-thumb-275x237-35572.jpgThe National Association of Consumer Bankruptcy Attorneys (NACBA) prepared a report regarding the dischargeability of student loans in the bankruptcy court. I have summarized the report below, but click here to review the entire report .

According to the NACBA, Americans now owe more on student loans than on credit cards. The amount of student borrowing crossed the $100 billion threshold for the first time in 2010 and total outstanding loans and exceeded $1 trillion for the first time last year. The reason: Students and workers seeking retraining are borrowing extraordinary amounts of money through federal and private loan programs to help cover the rising cost of college and training. In many cases, parents responsible for the student loans are in or near retirement years and facing repayment demands.

How big is the danger to the U.S. economy? "Evidence is mounting that student loans could be the next trouble spot for lenders," said Dr. Andrew Jennings, chief analytics officer at FICO and head of FICO Labs.

With rising debt comes increased risk, both to borrowers and to the economy in general. Even in the best of economic times when jobs are plentiful, young people with considerable debt burdens end up delaying life-cycle events such as buying a car, purchasing a home, getting married and having children. Piling up student loans in middle age is even more troublesome. Aside from the simple truth that there is less time to earn back the money, it also means facing retirement years still deeply in debt. And, parents who take out loans for children or co-sign loans will find those loans more difficult to pay as they stop working and their incomes decline.

This concern is echoed by bankruptcy attorneys from across the country who report that what they are seeing at the ground level feels too much like what they saw before the foreclosure crisis crashed onto the national scene: more and consumers seeking their help with unmanageable student loan debt, and with no relief available.

Missing just one student loan payment puts a borrower in delinquent status. After nine months of delinquency a borrower is in default. As younger college students, middle aged borrowers and parents all have taken on bigger student loan burdens, the level of defaults has risen. Although the Department of Education's official default rate for 2009 was 8.8 percent, the figure reflects only those debtors who began repayment in fiscal year 2009 and failed to meet the obligation by September 30, 2010, not all the people who defaulted over time.7

While any default hurts a borrower's credit, the consequences of a default on a student loan is particularly onerous. Once a default occurs, the full amount of the loan is due immediately. The government also cuts off any future federal financial aid and strips the borrower's eligibility for loan forgiveness.

For those with federal student loans, the government has collection powers far beyond those of most creditors. The government can garnish a borrower's wages without a judgment, seize a tax refund (including an earned income tax credit) or portions of federal benefits such as Social Security, and deny eligibility for new education grants or loans. The government can sue the borrower to place liens on bank accounts and property, and can tack on collection fees of 30 percent of the amount due. There is no discharge in bankruptcy for federal loans except in extremely limited circumstances that require a borrower to file a lawsuit that few bankruptcy debtors can afford, especially because student loan servicers aggressively litigate such cases. Unlike any other type of debt, there is no statute of limitations. The government can pursue borrowers to the grave. And, for those with professional licenses, failure to pay student loan debt can result in the loss of the state-issued license.

Student loans are among the few types of debts that generally are not dischargeable in bankruptcy. In contrast to student loans, most other debts are dischargeable in either a Chapter 7 liquidation process orChapter 13 debt adjustment plan. Other debts singled out as non-dischargeable include child support, alimony, court restitution orders, criminal fines and some taxes.

It wasn't always this way. Prior to 1976, all student loan debt was dischargeable in bankruptcy, just as if it were any other type of unsecured debt. That year, Congress added an exception to the bankruptcy discharge by prohibiting the discharge of education loans made by the government or a non-profit college or university, unless those loans had been in repayment for five years. That exception was continued in the 1978 Bankruptcy Act, but debtors who completed a chapter 13 plan, paying all they could afford over three to five years, were not subject to the five year waiting period. Since 1978, there have been three significant legislative changes in the treatment of student loans in bankruptcy.

The only exception to the nondischargeability of student loan debt is if the debtor can persuade the bankruptcy court that repayment of the loan would result in "undue hardship." There is no statutory definition of "undue hardship." This is a court-defined term, usually satisfied only if the debtor can meet the three-pronged test set forth in Brunner v. New York State Higher Education under which the debtor must demonstrate: (1) she cannot maintain a minimal standard of living for herself or her dependents if forced to repay the loan, (2) circumstances exist indicating this state of affairs is likely to persist for a significant portion of the repayment period, and (3) the debtor has made a good faith effort to repay the loan. In certain courts, a somewhat more flexible "totality of the circumstances" test has been applied.

The Law Offices of James V. Sansone assists individuals file for bankruptcy protection under the United States Bankruptcy Code. We are located in Santa Rosa, California and serve clients throughout Sonoma County, Mendocino County, and Lake County, including Santa Rosa, Petaluma, Cotati, Rohnert Park, Sebastopol, Healdsburg, Sonoma, Kenwood, Glen Ellen, Windsor, Bodega Bay, Ukiah, Willits, Clearlake, Lakeport, and Kelseyville.

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