Wednesday, June 21, 2017 Commercial and Bankruptcy Law Rooms: Student Loan Debt: The Trillon Dollar Problem 11:30 a.m. 12:00 p.m.

Transcription

1 Wednesday, June 21, 2017 Commercial and Bankruptcy Law Rooms: Student Loan Debt: The Trillon Dollar Problem 11:30 a.m. 12:00 p.m. Presented by Nancy Thompson Nancy L. Thompson Law Office, P.C. 309 Court Avenue, Suite 217 Des Moines, IA

2 Nancy L. Thompson Nancy L. Thompson Law Office, P.C. 309 Court Avenue, Suite 217 Des Moines, IA Nancy L. Thompson, Staff Attorney Iowa Legal Aid th Street, Suite ext nlthompson@iowalaw.org I. Introduction STUDENT LOAN DEBT The Trillion Dollar Problem Nearly 45 million Americans have student loan debt totaling almost $1.4 trillion and growing every day. Student loan debt is nearly equal to the combined amount of credit card and auto loan debt in the United States. Regardless of the type of college attended, over 70% of students graduate with debt owed, but nearly 90% of graduates of for-profit schools owe student loan debt. About 40% of the $1.4 trillion was used to finance graduate and professional degrees (nearly three quarters of new Iowa lawyers have at least $75,000 of student loan debt). According to the Consumer Financial Protection Bureau (CFPB), consumers age 60 and older are the fastest growing age group with student loans. The number of consumers age 60 and older with outstanding student loan debt quadrupled between 2005 and The average amount of student loan debt owed by this older age group doubled during the same time period, increasing to nearly $24,000. In 2015, 37% of federal student loan borrowers age 65 and older were in default and 40,000 of those borrowers had their Social Security benefits offset to repay their student loans. In 2014, 39% of consumers age 60 and older with a student loan said they had skipped necessary health care needs such as prescription medicine, doctor s visits and dental 1

3 care because they couldn t afford it. This compares to only 25% of older consumers without a student loan saying they had skipped such care. Consumers aged who have student loan debt also have less saved for retirement than those without student loan debt. The average monthly student loan payment is about $350, with the average loan balance almost $40,000 per borrower ($29,500 for graduates of Iowa colleges and universities). Nearly ten million borrowers of federal loans are either in default or have their loans in deferment or forbearance status where no payments are being made. Another six million student loan borrowers are in a repayment plan based on the amount of their income because they can t afford a traditional repayment plan. About 11% of all student loans are delinquent. Private student loan debt is also increasing. The amount of private student loan funds borrowed now exceeds $6 billion each year, with twenty percent of graduate loans now being private loans. Undergraduates are also borrowing more private loans and the refinancing market is booming as some private lenders offer lower interest rates than what is charged on federal loans. With the cost to attend even public universities or community colleges increasing each year, the need for student loans and the problems created by borrower inability to repay these loans is sure to also increase. II. Types of Student Loans The first question to ask any student loan borrower seeking legal assistance is Are your loans federal or private? The answer will determine what options for addressing a delinquency are available to the borrower. Federal student loans have a variety of different repayment options and methods for dealing with default. Private student loans provide no mandatory options for repayment or default resolution although some private lenders have adopted their own internal programs to help struggling borrowers. Private loans do provide protections available to 2

4 borrowers of any consumer loan, including the statute of limitations, fair debt collection restrictions and right to cure notice requirements. The availability of a discharge in bankruptcy is may also be dependent on whether the loan is federal or private. III. Dealing with Delinquent Federal Student Loans There are numerous methods for dealing with delinquent federal loans. Although this might be perceived as a benefit to borrowers, the complexity of navigating the various repayment options, regulations and procedures is so great many borrowers are unable to take advantage of the programs. Loan servicers tasked with helping borrowers get into the programs are also inadequately trained to explain their requirements and program procedures change frequently. But the competition to be awarded one of the contracts to collect delinquent federal student loan debt is fierce. In 2016 forty-eight different debt collectors applied to win just one of seven contracts awarded by the U.S. Department of Education. Each contract is expected to earn fees in excess of $300 million. The CBE Group in Cedar Falls was one of the seven successful debt collectors awarded a contract by the Department of Education. Complaints about federal student loan servicers are on the rise. Older borrowers especially have complained of alleged misinformation about repayment options and misallocation of payments by loan servicers. The Consumer Financial Protection Bureau has sued one of the former servicers, Navient, for its alleged failure to correctly service federal loans and to accurately advise borrowers of their repayment options. In response to the CFPB lawsuit, Navient filed a motion to dismiss, arguing it was never obligated to act in the interest of the consumer. Navient s motion said borrowers could not reasonably rely on it to advise them of alternative payment plans, despite years of marketing itself to the federal government and to 3

5 borrowers as an entity that would answer borrower questions and provide solutions so they could successfully repay their student loans. Some attorneys have begun devoting their entire law practice to helping student loan borrowers deal with delinquent federal loans. One good source of information for borrowers and attorneys is This website, maintained by the National Consumer Law Center, helps borrowers work through options at various stages of the loan process. A. Loan Discharges Outside Bankruptcy Federal student loan borrowers may have their loans discharged outside of bankruptcy under several different programs: (1) Borrowers who can show a Total and Permanent Disability ( TPD ) may have their loans discharged. Regulations at 34 C.F.R (b) allow a borrower to request a discharge of their federal loans with a doctor s certification that they are unable to earn a substantial income as a result of a physical or mental disability. Borrowers can also use a Social Security Disability award letter in lieu of the doctor s certification. Veterans who have been determined by the VA to be unemployable because of a service-connected disability may also request a discharge of their federal loans. There is a monitoring period following the approval of a TPD discharge with restrictions on how much income can be earned by the borrower during the monitoring period. Debt discharged through a TPD is taxable income and may result in taxes owed on the amount forgiven unless the borrower qualifies for an exclusion for insolvency. (2) A Closed School Discharge allows borrowers who were attending a school that closes at the time they were enrolled to request that their federal loans be discharged. Borrowers 4

6 must show they were unable to complete the program at another school or were unable to transfer credits to another school. See 34 C.F.R (3) A False Certification Discharge allows a borrower to request discharge of loans when a school falsely certifies that the student was eligible for the loan. For example, a student who has failed to graduate from high school or obtain an equivalent certification is not an eligible student. Borrowers may also apply for a false certification discharge in the case of identity theft. (4) A Death Discharge allows a loan discharge for a parent or surviving spouse if the student borrower dies. (5) The Teacher Loan Forgiveness Program allows teachers to have up to $17,500 of federal student loans forgiven if they meet the repayment requirements under 34 C.F.R (6) The Public Service Loan Forgiveness Program allows borrowers employed in public service to have the remaining balance of their loans forgiven after they make 120 loan payments. There are restrictions, however, on the type of employer that qualifies for this program and it is only available to borrowers with direct federal loans. Many borrowers with loans guaranteed by a state guaranty agency or non-profit and insured by the federal government have mistakenly believed that their loans are eligible for this program. See 34 C.F.R The regulations state that debt forgiven under the Public Service Loan Forgiveness Program is not taxable income. (7) Survivors of or eligible victims of the September 11 th attacks in New York City may request discharge of their federal student loans. B. Loan Repayment Options 5

7 Federal student loan borrowers facing financial hardship severe enough to not be able to make their loan payments have options available to them. Borrowers who default on payments can either rehabilitate their loan or consolidate into a new loan. After rehabilitation or consolidation, a borrower can get into an income based or income contingent repayment program. Rehabilitation requires borrowers to make nine monthly payments over a ten-month period. Payments must not be more than what is reasonable and affordable for the borrower. However, collection fees up to 16% of the unpaid principal and interest are capitalized into the loan balance upon completion of the rehabilitation. Rehabilitation is only available one time to borrowers who default on their loan payments. After rehabilitation, a borrower can select an income based (IBR) or income contingent (ICR) repayment plan. See 34 C.F.R (for guaranteed loans) or 34 C.F.R (for direct loans). Borrowers in default can also consolidate their loans into the direct loan program and then select an income based or income contingent repayment plan. They will also face an additional collection fee of up to 16% of the balance. The IBR program allows borrowers with a financial hardship to reduce their monthly loan payments. The payment cannot exceed 15% of the borrower s household income above 150% of the applicable poverty level, divided by 12. The payment is recalculated every year and if a borrower successfully pays for 25 years the remaining balance is forgiven. However, the debt forgiven is treated as taxable income. The ICR program also allows borrowers to reduce their monthly payments. The ICR payment cannot exceed 20% of a borrower s household income above 100% of the poverty level divided by 12. The payments are recalculated annually and again result in high 6

8 collection fees and forgiveness of debt after 25 years. The ICR is the only program available to Parent PLUS borrowers. The Pay As You Earn ( PAYE ) plan is available to borrowers with loans disbursed in or after Eligible borrowers pay 10% of their discretionary income and can have the loan balance forgiven after 20 years. See 34 C.F.R (a)(1). The Revised Pay As You Earn ( REPAYE ) program is available to direct loan borrowers and allows borrowers to pay 10% of their discretionary income. Borrowers with undergraduate loans are eligible for loan forgiveness after 20 years of repayment but borrowers with graduate loans are eligible for forgiveness after 25 years of payments. The Income Sensitive Repayment Plan ( ISRP ) is only available to borrowers with guaranteed federal student loans and the payments can fluctuate based on a borrower s annual income. Deferments and forbearances are available to borrowers facing financial hardship or those who are in school full-time. These options do nothing however to create long-term solutions for defaults. Interest continues to accrue on unsubsidized loans and will be capitalized into the principal when the deferment or forbearance period ends if it hasn t been paid otherwise. Since payments are not being paid during the deferment or forbearance periods borrowers are not making any progress towards having the loan balances forgiven. The ease of granting a deferment or forbearance makes it a favorite solution offered by loan servicers however. In a 2013 conference call with investors, a Navient official said it was less expensive to put borrowers into forbearance than to help them get into an income based repayment plan that would eventually result in a forgiveness of the loan. 7

9 IV. Dealing with Delinquent Private Student Loans Private student loan lenders are not required to offer any particular payment arrangements. They are required to comply with any state law on the collection of consumer debts. For example, borrowers might have defenses related to the statute of limitations, real party in interest, notice to cure requirements and cosigner notice requirements. See Student Loan Marketing Association v. Holloway, 25 S.W. 3d 699 (Mo. Ct. App. 2000); Henggeler v. Brumbaugh & Quandahl, P.C. 894 F. Supp. 2d 1180 (D. Neb. 2012); National Collegiate Student Loan Trust v. Thomas, 129 So. 3d 1231 (La. Ct. App. 2013); National Collegiate Student Loan Trust v. Lafavers (Ky. Cir. Ct. Pulaski County, October 1, 2013). V. Discharging Student Loans in Bankruptcy As An Undue Hardship The Bankruptcy Code at 11 U.S.C. 523(a)(8)(A) prohibits the discharge of (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 unless excepting the debt from discharge would impose an undue hardship on the debtor and the debtor s dependents. The Bankruptcy Code does not define undue hardship in the context of a discharge of student loans, but there is history that s instructive about what Congress meant when it adopted the undue hardship standard. In adopting 11 U.S.C. 523(a)(8), Congress relied on a draft bill prepared by the Commission on the Bankruptcy Laws of the United States. The undue hardship standard was taken directly from the Commission s draft bill. The Commission s report describes what it meant by the term undue hardship as follows: 8

10 In order to determine nondischargeability of the debt will impose an undue hardship on the debtor, the rate and amount of his future resources should be estimated reasonably in terms of ability to obtain, retain, and continue employment and the rate of pay that can be expected. Any unearned income or other wealth which the debtor can be expected to receive should also be taken into account. The total amount of income, its reliability, and the periodicity of its receipt should be adequate to maintain the debtor and his dependents, at a minimal standard of living within their management capability, as well as to pay the education debt. Report of the Commission on the Bankruptcy Laws of the United States, H.R. Doc. No , Pt. II (1973). The Commission s description of undue hardship contains no support for a harsh requirement of certainty of hopelessness or total incapacity. (One outrageous opinion required the borrower to show that repaying his student loans would strip[] himself of all that makes life worth living, In re Courtney, 79 B.R (Bankr. N.D. Ind. 1987). ) The Report s description of undue hardship also focuses on a debtor s present and future financial income and resources. There is no suggestion that a debtor s past conduct or payment history or reason for filing bankruptcy is to have any bearing on a Debtor s ability to discharge the student loans. Congress has also adopted an undue hardship analysis in the context of the approval of reaffirmation agreements. In 2005 Congress added language to the Code to help perform the undue hardship analysis. It said, it shall be presumed that such agreement is an undue hardship on the debtor if the debtor s monthly income less the debtor s monthly expenses.is less than the scheduled payments on the reaffirmed debt. This analysis also looks only at present and future income and resources. Unfortunately, neither of the predominant tests for determining eligibility for a discharge of student loans in bankruptcy has adhered to the language of the Code and the legislative history surrounding the adoption of the undue hardship standard. 9

11 The 8 th Circuit has adopted a totality of the circumstances test that considers (1) the debtor s past, current, and reasonably reliable future financial resources; (2) the debtor s and the debtor s dependents reasonable necessary living expenses; and (3) any other relevant facts and circumstances applicable to the bankruptcy case. See In re Long, 322 F.3d 549 (8 th Cir. 2003). The totality of the circumstances test is in contrast to the test adopted in 1987 in Brunner v. New York State Higher Education Services Corporation, 831 F. 2d 395 (2d Cir. 1987) (the Brunner test ). Undue hardship under the Brunner test requires the borrower to show that (1) the debtor cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and the debtor s dependents if forced to repay the student loans; (2) additional circumstances exist indicating that this situation is likely to persist for a significant portion of the repayment period; and (3) the debtor has made good faith efforts to repay the loans. The Brunner test was adopted at a time when the Code allowed a discharge of student loans that had been in repayment for more than five years. The case involved a pro se debtor with no dependents filing bankruptcy just one month after her loans to obtain a Master s degree went into repayment status. An empirical study of the Brunner test s application shows that debtors similarly situated by demographics and financial circumstances are typically not treated the same among courts. No statistical differences exist in the factual circumstances between debtors granted or denied a discharge of their student loans under the Brunner test. Both courts and commentaries have pointed out there is no support in the legislative history for the imposition of a good faith or additional circumstances standard to the finding of undue hardship. Despite being widely criticized, however, the Brunner test applies in all circuits other than the 8 th and the 1 st Circuit, where bankruptcy courts have used both the Brunner and the totality of 10

12 the circumstances test. A 1 st Circuit Bankruptcy Appellate Panel has adopted a totality of the circumstances test that essentially asks, Can the debtor now, and in the foreseeable near future, maintain a reasonable minimal standard of living for the debtor and the debtor s dependents and still afford to make payment on the debtor s student loans? See In re Bronsdon, 435 B.R. 791 (B.A.P. 1 st Cir. 2010) (rejection of Brunner test necessary because of improper requirements of good faith, certainty of hopelessness and other strict standards.) The Bronsdon B.A.P. decision was later affirmed with an unpublished judgment by the 1 st Circuit Court of Appeals stating, Debtor has demonstrated undue hardship under both the totality of circumstances and the Brunner tests. Therefore, we make no ruling as to which of the two tests is appropriate. No (1 st Cir. Sept. 23, 2011). The application of the totality of the circumstances test to an individual borrower s fact situation has, not surprisingly, created a wealth of litigation. Unfortunately, elements of the Brunner test have often made their way into cases supposedly decided under the totality of the circumstances test. For example, the imposition of a good faith requirement has been used in determining eligibility for a discharge despite the 8 th Circuit s rejection of the Brunner test. Some courts have perceived the third element of the totality of the circumstances test, i.e. any other relevant fact or circumstances, as justifying the imposition of a good faith standard. See Nelson v. TG Collections and Texas Guaranteed Student Loan Corporation, 343 B.R. 919 (Bankr. S.D. Iowa 2006) (third factor of test allows flexibility to consider factors like debtor s good faith effort to repay loan or obtain employment or minimize expenses); VerMaas v. Student Loans of N.D., 302 B.R. 650, (Bankr. D. Neb. 2003) (factors to be considered include a debtor s good faith effort to negotiate deferment or forbearance, whether the debtor has made past payments on the loan, whether the debtor has made good faith efforts to maximize income and 11

13 minimize expenses, whether the dominant purpose of the bankruptcy is to discharge the student loan, and the ratio of student loan debt to total indebtedness). A certainty of hopelessness requirement, a common standard of courts using the Brunner test, has also been used in cases denying discharge under the totality of the circumstances test, despite a lack of legislative support for rigid standards that go beyond an analysis of a debtor s foreseeable financial hardship. See DeBrower v. Pennsylvania Higher Education Assistance Agency, 387 B.R. 587, (Bankr. N.D. Iowa 2008) (Debtors must show by a preponderance of the evidence a certainty of hopelessness to overcome student loan exception to discharge.); In re Randall, 255 B.R. 570 (Bankr. D. N.D. 2000) (totality of circumstances test requires total incapacity to repay debts at time of filing and on into the future). 1. Income Based Repayment Programs as Barrier to Discharge The Department of Education frequently opposes discharge of federal student loans in bankruptcy by arguing that borrowers eligible to participate in one of the administratively administered income based repayment (IBR) programs should not be granted a discharge. Under the Brunner test, courts have considered a borrower s efforts at participating in these repayment programs as a test of the borrower s good faith. See In re Nys, 446 F.3d 938 (9 th Cir. 2005) and In re Frushour, 433 F.3d 393 (4 th Cir. 2005). Under the totality of the circumstances test, courts have ruled that a borrower s eligibility to participate in one of the income based repayment programs is one factor, but not a determining factor, in determining the existence of undue hardship. See In re Jesperson, 571 F.3d 775 (8 th Cir. 2009); In re Nielson, 473 B.R. 755 (B.A.P. 8 th Cir. 2012), aff d, 502 Fed. Appx. 634 (8 th Cir. 2013) (unpublished decision); In re Nielson, 518 B.R. 529 (8 th Cir. BAP 2014); In re Fern, 563 B.R. 1 (B.A.P. 8 th Cir. 2017), In re Abney, 2015 Bankr. LEXIS

14 (Bankr. W.D. Missouri 2015); In re Vest, 2011 WL (Bankr. S.D. Iowa 2011); In re Gitsch, 384 B.R. 555 (Bankr. N.D. Iowa 2008). Besides a lack of support in the text of the statutory language or the Code s legislative history for using a borrower s participation or lack of participation in income based repayment programs to determine undue hardship, the programs themselves are poor substitutes for a discharge of the loans. For example, borrowers on income based repayment programs face multiple obstacles to completing the years of payments necessary for the programs. Annual recertification of eligibility is required and borrowers have reported numerous problems with the recertification process. Even sophisticated borrowers with intimate knowledge of the program requirements have described problems such as delays and errors that result in termination from the programs. Some borrowers have reported being unilaterally put into loan deferment by a servicer, despite being current on their IBR program payments. A borrower in an IBR program will still have a credit report showing the full amount of the debt being owed, with accruing interest increasing the debt each year. The negative impact on a borrower s credit is likely to affect future eligibility for credit and place a higher cost on any credit obtained. Even borrowers who successfully navigate their way through years of one of the income based repayment plans face tax consequences from the forgiveness of the debt. In short, as one court stated, had Congress wanted the IBR programs to operate as a repeal of the Bankruptcy Code s student loan discharge provision, it could have done so. See In re O Donhoe, 2013 WL (Bankr. S.D. Tex. June 13, 2013). See also In re Lee, 352 B.R. 91 (B.A.P. 8 th Cir. 2006). 2. Evaluating Loans Separately For Discharge The 8 th Circuit Bankruptcy Appellate Panel has ruled that while a partial discharge of student loans is not permitted under the Code, loans are to be evaluated separately when determining 13

15 whether repayment is an undue hardship. See Andresen v. Nebraska Student Loan Program, Inc. (In re Andresen), 232 B.R. 127 (8 th Cir. BAP 1999); In re Shaffer, 481 B.R. 15 (8 th Cir. BAP 2012); In re Conway, 495 B.R. 416 (8 th Cir. BAP 2013); In re Conway, 542 BR 855 (8 th Cir. BAP 2015). VI. Discharging Private Student Loans in Bankruptcy In 2005 Congress added new subsection (B) to 11 U.S.C. 523(a)(8). It expanded the nondischargeability of student loans to include 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. Generally, this expanded the nondischargeability of student loans to private student loans. However, by limiting the exclusion to qualified education loans, Congress left open the possibility of discharging certain private student loans. The Internal Revenue Code (26 U.S.C. 221(d)) defines qualified education loan as any indebtedness incurred by the taxpayer solely to pay for qualified higher education expenses (A) which are incurred on behalf of the taxpayer, the taxpayer s spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred, (B) which are paid or incurred within a reasonable period of time before or after the indebtedness is incurred, and (C) which are attributable to education furnished during a period during which the recipient was an eligible student. The Internal Revenue Code defines qualified higher education expenses at 26 U.S.C. 221(d)(2) to broadly include such things as tuition, fees, room and board, books, supplies, transportation and even the purchase of a computer. However, the qualified expenses are limited to the cost of attendance at the school for the student and the expenses must be for attendance at an eligible education institution, defined as an institution eligible to participate in a Title IV 14

16 federal financial assistance program. See 26 U.S.C. 25A(f)(2). The Federal School Codes List is updated several times each year and lists each college or university eligible to participate in Title IV programs. These definitions create several openings for the discharge of private student loans in bankruptcy regardless of whether the borrower can prove an undue hardship. For example, if the private student loan was incurred for a purpose other than to pay for education expenses it should be dischargeable. Private student loans incurred to pay off credit card debt or make home improvements as well as educational expenses ( mixed use loans) should be dischargeable because the loan was not made solely for the purpose of paying education expenses. See Example 6 of 26 CFR (e)(4). If a student loan borrower is not an eligible student the loan should be dischargeable. For example, some for-profit schools aggressively market to people who have not yet graduated from high school or obtained their HiSET (formerly GED) or High School Equivalency Test. These students should be able to discharge loans obtained prior to the time they became eligible. To be an eligible student, the borrower must be enrolled at least half-time and be seeking a degree. Study abroad is only eligible to the extent it is approved for credit by the home college or university. The expenses must be incurred on behalf of the debtor, the debtor s spouse or a dependent of the debtor. A grandmother or favorite uncle who co-signed for the student debtor should be able to discharge in bankruptcy any private student loans incurred, unless the student was a dependent. See 26 CFR (b)(2). 15

17 Private student loans incurred at institutions that are not eligible to participate in federal financial assistance programs should be dischargeable. For example, private student loans to attend many diploma mills or unaccredited schools should be dischargeable. VII. Discharging Education Debts That Are Not Loans in Bankruptcy The bankruptcy code provision allowing for the discharge of student loans applies to an educational benefit overpayment or loan made.or an obligation to repay funds received as an educational benefit, scholarship, or stipend. Debts incurred where no loan was made or funds received, such as tuition or parking fees, should be dischargeable. See In re Chambers, 348 F (7 th Cir. 2003); In re Mehta, 310 F. 3d 308 (3d Cir. 2002). But see In re Capron, 454 B.R. 738 (Bankr. N.D. Iowa 2011) and In re Johnson, 218 B.R. 449 (8 th Cir. BAP 1998). VIII. Conclusion With financial assistance to students declining, student loan debt is sure to increase significantly in the coming years. Although help is available to borrowers through repayment programs and loan discharges, the sophistication required to successfully obtain that help is high. The assistance of attorneys is likely to be the only way some borrowers will ever be free of their student loan debt. 16