Student Loans In The United States - Private Student Loan Bankruptcy Discharge

Student loans in the United States are a form of financial aid that must be repaid, in contrast to other forms of financial aid such as scholarships and grants. Student loans play a very large role in U.S. higher education. Nearly 20 million Americans attend college each year. Of that 20 million, close to 12 million - or 60% - borrow annually to help cover costs. In Europe, higher education is more highly subsidized for students and funded by the government. In parts of Asia and Latin America most post-secondary education is still private with little funding from the government. However, in the U.S., much of college is funded by students and their families with public institutions being funded in part through state and local taxation, and both private and public institutions through additional gifts from donors and alumni. Some believe this substantially increases intergenerational correlations in income, although other transmissions including genetics, work ethic, and preferences for work versus leisure have been shown to play a larger combined role in some studies. Nonetheless, higher education in the U.S. has been shown to be an excellent investment both for individuals and for the public, even though differences in the returns to educational investment across schools has been overstated in many cases.

Student loans come in several varieties in the United States, but are basically split into federal loans and private student loans. Some states have their own loan programs, as do some colleges. In almost all cases, federal student loans are less expensive and have better conditions - sometimes much better - than the heavily-advertised private student loans.

Student loans may be used for any college-related expenses, including tuition, room and board, books, computers, and transportation expenses.

Federal student loans made to students directly: The student makes no payments while enrolled in at least half-time status. If a student drops below half time, the account goes into a six-month grace period. If the student re-enrolls in at least half time status, the loans are deferred, but when they drop below half time again they no longer have access to a grace period and repayment must begin. Many student loans receive subsidies from the federal government. Amounts are limited,. There are many deferments and a number of forbearances (cancellation of loan) one can get in the Direct Loan program. For those who are disabled, there is also the possibility of 100% loan discharge (cancellation of loan) if you meet the requirements. Due to changes by the Higher Education Opportunity Act of 2008, it became easier to get one of these discharges after July 1, 2010. There are loan forgiveness provisions for teachers in specific critical subjects or in a school with more than 30% of its students on reduced-price lunch (a common measure of poverty), and qualify for loan forgiveness of all their Stafford, Perkins, and FFEL loans totalling up to $77,500. In addition, any person employed full-time (in any position) by a public service organization, or serving in a full-time AmeriCorps or Peace Corps position qualifies for loan forgiveness (cancellation) after 10 years of 120 consecutive payments without being late. Some loan forgivenesses or discharges are considered taxable income by the Internal Revenue Service under 26 U.S.C. 108(f).
Federal student loans made to parents: Much higher limit, but payments start immediately.
Private student loans made to students or parents: Higher limits and no payments until after graduation, although interest starts to accrue immediately. Interest rates are higher than federal loans. Students often use private loans to supplement federal student loans. However, any college financial aid officer will recommend you borrow the maximum under federal programs before turning to private loans.

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Federal loans

Federal loans to students

See Federal Perkins Loan, Stafford loan, Federal Direct Student Loans, and Federal student loan consolidation

U.S. Government-backed student loans were first offered in the 1950s under the National Defense Education Act (NDEA), and were only available to select categories of students, such as those studying toward engineering, science, or education degrees. The student loan program was established in response to the Soviet Union (USSR's) launch of the Sputnik satellite, and a widespread perception that the United States was falling behind on education and technology in the Cold War. Student loans were extended more broadly in the 1960s under the Higher Education act, with the goal of encouraging greater social mobility and equality of opportunity.

Prior to 2010, Federal loans included both direct loans--originated and funded directly by the U.S. Department of Education--and guaranteed loans--originated and funded by private investors, but guaranteed by the federal government. Guaranteed loans were eliminated in 2010 through the Student Aid and Fiscal Responsibility Act and replaced with direct loans because of a belief that guaranteed loans benefited private student loan companies at taxpayers expense, but did not reduce costs for students.

These loans are available to college and university students via funds disbursed directly to the school and are used to supplement personal and family resources, scholarships, grants, and work-study. They may be subsidized by the U.S. Government or may be unsubsidized depending on financial need. The U.S. Department of Education published a booklet comparing federal loans with private loans. In this same document, the government describes what you may use the loan for:

You may use the money you receive only to pay for education expenses at the school that awarded your loan. Education expenses include school charges such as tuition; room and board; fees; books; supplies; equipment; dependent childcare expenses; transportation; and rental or purchase of a personal computer.

Both subsidized and unsubsidized loans are guaranteed by the U.S. Department of Education either directly or through guaranty agencies. Nearly all students are eligible to receive federal loans (regardless of credit score or other financial issues). Federal student loans are not priced according to any individualized measure of risk, nor are loan limits determined based on risk. Rather, pricing and loan limits are politically determined by Congress. Undergraduates typically receive lower interest rates, but graduate students typically can borrow more. This lack of risk-based pricing has been criticized by scholars as contributing to inefficiency in higher education.

Both types offer a grace period of six months, which means that no payments are due until six months after graduation or after the borrower becomes a less-than-half-time student without graduating. Both types have a fairly modest annual limit. The dependent undergraduate limit effective for loans disbursed on or after July 1, 2008 is as follows (combined subsidized and unsubsidized limits): $5,500 per year for freshman undergraduate students, $6,500 for sophomore undergraduates, and $7,500 per year for junior and senior undergraduate students, as well as students enrolled in teacher certification or preparatory coursework for graduate programs. For independent undergraduates, the limits (combined subsidized and unsubsidized) effective for loans disbursed on or after July 1, 2008 are higher: $9,500 per year for freshman undergraduate students, $10,500 for sophomore undergraduates, and $12,500 per year for junior and senior undergraduate students, as well as students enrolled in teacher certification or preparatory coursework for graduate programs. Subsidized federal student loans are only offered to students with a demonstrated financial need. Financial need may vary from school to school. For these loans, the federal government makes interest payments while the student is in college. For example, those who borrow $10,000 during college owe $10,000 upon graduation.

Unsubsidized federal student loans are also guaranteed by the U.S. Government, but the government does not pay interest for the student, rather the interest accrues during college. Nearly all students are eligible for these loans regardless of demonstrated need. Those who borrow $10,000 during college owe $10,000 plus interest upon graduation. For example, those who borrowed $10,000 and had $2,000 accrue in interest owe $12,000. Interest begins accruing on the $12,000. The accrued interest is "capitalized" into the loan amount, and the borrower begins making payments on the accumulated total. Students can pay the interest while still in college, but few students do so.

Federal student loans for graduate students have higher limits: $8,500 for subsidized Stafford and $12,500 (limits may differ for certain courses of study) for unsubsidized Stafford. Many students also take advantage of the Federal Perkins Loan. For graduate students the limit for Perkins is $6,000 per year.

Stafford loan aggregate limits

Students who borrow money for education through Stafford loans cannot exceed certain aggregate limits for subsidized and unsubsidized loans. For undergraduate dependent students, the maximum aggregate limit of subsidized and unsubsidized loans combined is $57,500, with subsidized loans limited to a maximum of $23,000 of the total loans. Students who have borrowed the maximum amount in subsidized loans may (based on grade level--undergraduate, graduate/professional, etc.) take out a loan of less than or equal to the amount they would have been eligible for in subsidized loans. Once both the subsidized and unsubsidized aggregate limits have been met for both subsidized and unsubsidized loans, the student is unable to borrow additional Stafford loans until they pay back a portion of the borrowed funds. A student who has paid back some of these amounts regains eligibility up to the aggregate limits as before.

Federal student loans to parents

See PLUS loan

Usually these are PLUS loans (formerly standing for "Parent Loan for Undergraduate Students"). Unlike loans made to students, parents can borrow much more -- usually enough to cover any gap in the cost of education. Interest accrues during the time the student is in school. No payments are required until the student is no longer in school, although parents may start paying it back ahead of time if they want.

The parents are responsible for repayment on these loans, not the student. Loans to parents are not a 'cosigner' loan with the student having equal accountability. The parents have signed the master promissory note to repay the loan and, if they do not repay the loan, the credit rating of the parents may suffer. Also, parents are advised to consider "year 4" payments, rather than "year 1" payments. What sounds like a "manageable" debt load of $200 a month in freshman year can mushroom to a much more daunting $800 a month by the time four years have been funded through loans. The combination of immediate repayment and the ability to borrow substantial sums can be expensive.

Under new legislation, graduate students are eligible to receive PLUS loans in their own names. These Graduate PLUS loans have the same interest rates and terms of Parent PLUS loans.

Parents should also be aware that legislation raised the interest rate on these loans significantly -- to 8.5% on July 1, 2006.

Disbursement: How the money gets to student or school

Federal Direct Student Loans, also known as Direct Loans or FDLP loans, are funded from public capital originating with the U.S. Treasury. FDLP loans are distributed through a channel that begins with the U.S. Treasury Department and from there passes through the U.S. Department of Education, then to the college or university and then to the student.

According to the U.S. Department of Education, more than 6,000 colleges, universities, and technical schools participate in FFELP, which represents about 80% of all schools. FFELP lending represents 75% of all federal student loan volume.

In 2010, the Health Care Reform Act incorporated provisions on Education, which terminated the Federal Family Education Loan Appropriations after June 30, 2010. From that date on, all government-backed student loans have been issued through the Direct Loans program.

Debt levels

The maximum amount that any student can borrow is adjusted as federal policies change. Current loan limits are below the cost of most four year private institutions and most flagship public universities, and students therefore typically borrow higher cost private student loans to make up the difference. Scholars have advocated increasing federal debt limits to reduce the interest charges to student debtors.

The maximum amount that any student can borrow is adjusted as federal policies change. A study published in the winter 1996 edition of the Journal of Student Financial Aid, "How Much Student Loan Debt Is Too Much?" suggested that the monthly student debt payment for the average undergraduate should not exceed 8% of total monthly income after graduation. Some financial aid advisers have referred to this as "the 8% rule." Circumstances vary for individuals, so the 8% level is an indicator, not a rule set in stone. A research report about the 8% level is available at the Iowa College Student Aid Commission.

The Economist reported in June 2014 that U.S. student loan debt exceeded $1.2 trillion, with over 7 million debtors in default. Public universities increased their fees by a total of 27% over the five years ending in 2012, or 20% adjusted for inflation. Public university students paid an average of almost $8,400 annually for in-state tuition, with out-of-state students paying more than $19,000. For two decades ending in 2013, college costs have risen 1.6% more than inflation each year. Government funding per student fell 27% between 2007 and 2012. Student enrollments rose from 15.2 million in 1999 to 20.4 million in 2011, but fell 2% in 2012.

Private student loans

These are loans that are not guaranteed by a government agency and are made to students by banks or finance companies. Private loans are higher cost than federal loans, and are generally only used when students have exhausted the borrowing limit under federal student loans. They are also not eligible for Income Based Repayment plans, and frequently have less flexible payment terms, higher fees, and more penalties.

These are loans that are not guaranteed by a government agency and are made to students by banks or finance companies. Advocates of private student loans suggest that they combine the best elements of the different government loans into one: They generally offer higher loan limits than federal student loans, ensuring the student is not left with a budget gap. But unlike federal parent loans, they generally offer a grace period with no payments due until after graduation (this grace period ranges as high as 12 months after graduation, though most private lenders offer six months). However, some higher education advocates are private loan detractors because of the higher interest rates, multiple fees, and lack of borrower protections private loans carry that are not associated with federal loans.

Private student loan types

Private student loans generally come in two types: school-channel and direct-to-consumer.

School-channel loans offer borrowers lower interest rates but generally take longer to process. School-channel loans are "certified" by the school, which means the school signs off on the borrowing amount, and the funds are disbursed directly to the school.

Direct-to-consumer private loans are not certified by the school; schools don't interact with a direct-to-consumer private loan at all. The student simply supplies enrollment verification to the lender, and the loan proceeds are disbursed directly to the student. While direct-to-consumer loans generally carry higher interest rates than school-channel loans, they do allow families to get access to funds very quickly -- in some cases, in a matter of days. Some argue that this convenience is offset by the risk of student over-borrowing and/or use of funds for inappropriate purposes, since there is no third-party certification that the amount of the loan is appropriate for the education finance needs of the student in question.

Direct-to-consumer private loans was the fastest growing segment of education finance with the "percentage of undergraduates obtaining private loans from 2003-04 to 2007-08 rose from 5 percent to 14 percent" and were under legislative scrutiny due to the lack of school certification. Loan providers range from large education finance companies to specialty companies that focus exclusively on this niche. Lenders often push such loans by advertising: "no FAFSA required," or "Funds disbursed directly to you." But since the "passing of Health Care and Education Reconciliation Act of 2010(HCERA), the death knell sounded for private sector lending under the Federal Family Education Loan Program (FFELP). Since July 1, 2010, no new student loans have been made under the FFELP; all subsidized and unsubsidized Stafford loans, PLUS loans, and Consolidation loans have been made solely under the Federal Direct Loan Program."

Private student loan rates and interest

Private student loans typically have variable interest rates while federal student loans have fixed rates. Consumers should be aware that some private loans require substantial up-front origination fees. These fees raise the real cost to the borrower and reduce the amount of money available for educational purposes.

Most private loan programs are tied to one or more financial indexes, such as the Wall Street Journal Prime rate or the BBA LIBOR rate, plus an overhead charge. Because private loans are based on the credit history of the applicant, the overhead charge varies. Students and families with excellent credit generally receive lower rates and smaller loan origination fees than those with less than perfect credit. Money paid toward interest is now tax deductible. However, lenders rarely give complete details of the terms of the private student loan until after the student submits an application, in part because this helps prevent comparisons based on cost. For example, many lenders only advertise the lowest interest rate they charge (for good credit borrowers). Borrowers with bad credit can expect interest rates that are as much as 6% higher, loan fees that are as much as 9% higher, and loan limits that are two-thirds lower than the advertised figures.

Private student loan fees

Private loans often carry an origination fee. Origination fees are a one-time charge based on the amount of the loan. They can be taken out of the total loan amount or added on top of the total loan amount, often at the borrower's preference. Some lenders offer low-interest, 0-fee loans. Each percentage point on the front-end fee gets paid once, while each percentage point on the interest rate is calculated and paid throughout the life of the loan. Some have suggested that this makes the interest rate more critical than the origination fee.

In fact, there is an easy solution to the fee-vs.-rate question: All lenders are legally required to provide you a statement of the "APR (Annual Percentage Rate)" for the loan before you sign a promissory note and commit to it. Unlike the "base" rate, this rate includes any fees charged and can be thought of as the "effective" interest rate including actual interest, fees, etc. When comparing loans, it may be easier to compare APR rather than "rate" to ensure an apples-to-apples comparison. APR is the best yardstick to compare loans that have the same repayment term; however, if the repayment terms are different, APR becomes a less-perfect comparison tool. With different term loans, consumers often look to "total financing costs" to understand their financing options.

Private student loan cosigners

Eligible loan programs generally issue loans based on the credit history of the applicant and any applicable cosigner/co-endorser/coborrower. This is in contrast to federal loan programs that deal primarily with need-based criteria, as defined by the EFC and the FAFSA. For many students, this is a great advantage to private loan programs, as their families may have too much income or too many assets to qualify for federal aid but insufficient assets and income to pay for school without assistance.

Many international students in the United States can obtain private loans (they are usually ineligible for federal loans) with a cosigner who is a United States citizen or permanent resident. However, some graduate programs (notably top MBA programs) have a tie-up with private loan providers and in those cases no cosigner is needed even for international students.

Private student loan terms

The terms for private loans vary from lender to lender. A common suggestion is to shop around on all terms, not just respond to "rates as low as..." tactics that are sometimes little more than bait-and-switch. However, shopping around could damage your credit score. Examples of other borrower terms and benefits that vary by lender are deferments (amount of time after leaving school before payments start) and forbearances (a period when payments are temporarily stopped due to financial or other hardship). These policies are solely based on the contract between lender and borrower and not set by Department of Education policies.

Private student loan consolidation

Several lenders offer private consolidation programs. Borrowers of privately subsidized student loans may face the same restrictions to bankruptcy discharge as for government based loans: New legislation makes clear that these loans are, like federal student loans, not dischargeable under bankruptcy. Even before the legislation was passed, private student loans that were guaranteed "in whole or in part" by a nonprofit entity are non-dischargeable in bankruptcy (and most private loans, regardless of the lender, were guaranteed by a nonprofit). The interest rates on private loan consolidations are often not any better than the rates already available on the private loans separately.

Standard repayment

When Federal student loans enter repayment, they are automatically enrolled in standard repayment. Under it, a borrower has 10 years to repay the total amount of his or her loan. The loan servicer (whoever is sending the bill) determines the monthly bill by splitting the loan amount into 120 equal payments (12 payments per year).

Payments pay off the interest building up each month, plus part of the original loan amount. Depending on the amount of the loan, the loan term may be shorter than 10 years. There is a $50 minimum monthly payment.

Income-Based Repayment Plan

If a student's loan debt is high but their income is modest, they may qualify for the Income-Based Repayment Plan (IBR). Most major types of federal student loans--except for PLUS loans for parents--are eligible for IBR. Income-based plans provide for payment of 15% of disposable income for up to 25 years, then the loan is forgiven.

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Discharge of student loans

U.S. Federal student loans and some private student loans can be discharged in bankruptcy only with a showing of "undue hardship." In contrast to credit card debt, which often can be discharged through bankruptcy proceedings, this option is not generally available for educational loan debt. Additionally, those seeking to discharge their student loan debt must initiate an adversary proceeding, a separate lawsuit within the bankruptcy case where they illustrate the required undue hardship. Many borrowers cannot afford to retain an attorney or the additional litigation costs associated with an adversary proceeding, let alone a bankruptcy case. Further complicating matters, the undue hardship standard varies from jurisdiction to jurisdiction, but is generally difficult to meet, making student loans practically non-dischargeable through bankruptcy. In most circuits discharge depends on meeting three prongs in the Brunner test:

As noted by the district court, there is very little appellate authority on the definition of "undue hardship" in the context of 11 U.S.C. § 523(a)(8)(B). Based on legislative history and the decisions of other district and bankruptcy courts, the district court adopted a standard for "undue hardship" requiring a three-part showing: (1) that the debtor cannot maintain, based on current income and expenses, a "minimal" standard of living for herself and her dependents if forced to repay the loans; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans; and (3) that the debtor has made good faith efforts to repay the loans. For the reasons set forth in the district court's order, we adopt this analysis. The first part of this test has been applied frequently as the minimum necessary to establish "undue hardship." See, e.g., Bryant v. Pennsylvania Higher Educ. Assistance Agency (In re Bryant), 72 B.R. 913, 915 (Bankr.E.D.Pa.1987); North Dakota State Bd. of Higher Educ. v. Frech (In re Frech), 62 B.R. 235 (Bankr.D.Minn.1986); Marion v. Pennsylvania Higher Educ. Assistance Agency (In re Marion), 61 B.R. 815 (Bankr.W.D.Pa.1986). Requiring such a showing comports with common sense as well.

While federal student loans can be discharged administratively for total and permanent disability, private student loans cannot be discharged outside of bankruptcy.

One set of empirical data comes from Education Credit Management Corporation, which serviced loans for twenty-five lending agencies and the United States Department of Education; in 2008 it was reported that of 72,000 loans in bankruptcy proceedings, only 276 debtors attempted discharge, and by November 2009 of the 134 resolutions thus far, 29 resulted in total or partial discharge.

A review of records in the U.S. Bankruptcy Court for the Western District of Washington found that 57% of adversary the 115 adversary proceedings reviewed in a 5-year period resulted in partial discharge, through settlement or trial; however, the authors cautioned not to generalize the results of this small sample. 86% involved either (or both) the United States Department of Education or the Education Credit Management Corporation, a nonprofit which services loans where the student has declared bankruptcy.

The rules for total and permanent disability discharge underwent major changes as a result of the Higher Education Opportunity Act of 2008. Loan holders are no longer required to be unable to earn any income, but instead the standard is "substantial gainful activity" (SGA) as a result of disability. The new regulations took effect July 1, 2010. Under further changes set to take effect July 1, 2013, if a borrower is determined to be disabled by the Social Security Administration, that determination will be accepted as proof of total and permanent disability if the SSA placed the individual on a five- to seven-year review cycle (the longest currently used by SSA).

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Criticism of U.S. student loan programs

The federal student loan program has been criticized for not adjusting interest rates according to the riskiness of factors that are under students' control, such as choice of academic major. Critics have contended that this lack of risk-based pricing contributes to inefficiency and misallocation of resources in higher education, and lower productivity in the labor market. However, recent research indicates that while high levels of student loan debt, coupled with high default rates, present a number of challenges for individual student loan borrowers, they do not necessarily place a substantial burden on society at large.

After the passage of the bankruptcy reform bill of 2005, both federal and private student loans are not discharged during bankruptcy (prior to the passage of this bill, only federal student loans were unable to be discharged). This provided a credit risk free loan for the lender, averaging 7 percent a year. In January 2013, the "Fairness for Struggling Students Act" was unveiled. This bill, if passed, would once again allow private student loans to be discharged in bankruptcy. The bill was referred to the Senate Judiciary Committee where it died.

Some critics of financial aid claim that, because schools are assured of receiving their fees no matter what happens to their students, they have felt free to raise their fees to very high levels, to accept students of inadequate academic ability, and to produce too many graduates in some fields of study. About one-third of students, whether or not they graduate or find jobs that match their credentials, are financially burdened for much of their lives by their debt obligations, instead of being economically productive citizens. When those former students default on their obligations, the burdens are shifted to taxpayers. Lastly, the proportion of graduates who come from poor backgrounds has actually declined since 1970.

In 2007, the Attorney General of New York State, Andrew Cuomo, led an investigation into lending practices and anti-competitive relationships between student lenders and universities. Specifically, many universities steered student borrowers to "preferred lenders" that charged higher interest rates. Some of these "preferred lenders" allegedly rewarded university financial aid staff with kick backs. This led to changes in lending policy at many major American universities. Many universities have also rebated millions of dollars in fees back to affected borrowers.

The biggest lenders, Sallie Mae and Nelnet, are criticized by borrowers. They frequently find themselves embroiled in lawsuits, the most serious of which was filed in 2007. The False Claims Suit was filed on behalf of the federal government by former Department of Education researcher, Dr. Jon Oberg, against Sallie Mae, Nelnet, and other lenders. Oberg argued that the lenders overcharged the U.S. Government and defrauded taxpayers of over $22 million. In August 2010, Nelnet settled the lawsuit and paid $55 million.

In an effort to improve the student loan market, startups like LendKey, SoFi (Social Finance, Inc.), Konsolidate and CommonBond were founded to offer student loans and refinance loans at lower rates than traditional repayment systems using an alumni-funded model.

The New York Times published an editorial in 2011 in support of allowing private loans to again be discharged during bankruptcy.

In June 2010, the amount of student loan debt held by Americans exceeded the amount of credit card debt held by Americans. At that time, student loan debt totaled at least $830 billion, of which approximately 80% was federal student loan debt and 20% was private student loan debt. In October 2011, the total amount of money owed in student loan debt was said to exceed $1 trillion. This rising student debt is contributing to the expanding wealth gap.

With each passing year, student debt continues to rise. Nearly two-thirds of undergraduates are in debt. By graduation, their student loan debt averages around $26,600. An unlucky 1 percent of graduates leave college with $100,000 or more of student loan debt. In 2013, the federal debt had grown to $16.7 trillion. 6 percent of that debt comes directly from student loans making student loans only second to mortgages in consumer debt. The Consumer Financial Protection Bureau reported that as of May 2013, federal student loan debt had reached $1 trillion bringing the total number for outstanding student loan debt to $1.2 trillion. However, this amount does include what students take from savings accounts, borrow from parents, or charge to their credit cards in order to pay for their education. In actuality, the burden of student debt is much greater than these numbers indicate.

A Look at a Cosigners Navient Student Loans Discharged in Bankruptcy

References

National Assocition of Student Financial Aid Administrators.

External links

"College, Inc.", PBS FRONTLINE documentary, May 4, 2010
U.S. Dept. of Education

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