By: Austin Smith
The conventional wisdom that student loans are 100% non-dischargeable in bankruptcy is based on a fundamental misunderstanding of the legal system. In fact, this misconception completely ignores the difficulties and realities of litigation, and has at its core a prediction that debtors will lose 100% of the cases they file, and creditors will recover 100% of the money demanded. This is akin to wagering that the New York Yankees will win all 162 games they play next year by a score of 10-0. Yes, they are the Yankees. But no, they won’t win every game, let alone by 10 runs.
Because of the risks and expense of litigation, 99% of lawsuits end not in a dramatic trial but in a mutually acceptable truce. And that truce generally involves compromise on both sides depending on the merits and weakness of the given case. A good case can settle for as little as 25% of the total amount of student debt owed, whereas even a weaker case will settle for 75% of what is owed. So, instead of thinking of student loans as 100% non-dischargeable in bankruptcy, we should think of them as roughly 50% dischargeable in bankruptcy. That is, if you file for bankruptcy and seek to discharge your private student loans, you will very likely be able to wipe out at least 50% of the total value of the debt (and get into a reasonable payment plan while you’re at it.).
First, when you declare bankruptcy, the creditor bears the burden of proving the student loan falls within one of the enumerated exceptions to discharge. That is, the creditor needs to prove that its claimed damages are non-dischargeable under federal bankruptcy law. In order to do this, the creditor needs to prove you were a taxpayer when you borrowed the money, that the school you attended was Title IV accredited, that you borrowed within the “cost of attendance,” and that you were an eligible student under the Higher Education Act. This is extremely difficult and burdensome for the creditor to do, and gives an individual significant leverage.
Second, even if they are able to prove the debt is a non-dischargeable student loan, you get to try to prove repayment of the loans would constitute an “undue hardship.” Everyone will also tell you this is nearly impossible, but 47% of people who ignore the conventional wisdom and try this are successful. That does not mean you will be successful, what it means is that when the creditor is evaluating her chances at trial, she will know she only has a 53% chance of winning. Very few rational actors go to trial with those odds, especially when you consider the value of the debt she is trying to claim a legal right to collect.
Third, your debt is basically worthless on the secondary market. The bank may be claiming you owe them $100,000, but if they tried to sell that debt to a third party, they’d only get around $10,000, and more likely much less (according to the FTC, defaulted debt is worth about 4 cents on the dollar). That’s the “free market” value of your defaulted debt. The point is: this debt is essentially worthless, and there is only so much time and energy the bank is willing to spend to win the right to recover what is essentially valueless debt.
More bankruptcy lawyers are not litigators and therefore all too often ignore these sources of leverage. But if you are one of the millions of persons struggling under the weight of private student debt, bankruptcy litigation may provide a realistic way forward. No, it probably won’t get rid of all of you private student debt, but if you play the game properly, you’re likely going to come out ahead—or at least less far behind than you are now, and when it comes to student loans, that’s a major victory.
For a free consultation with Austin Smith, please reach his staff at 888-FAIRMAX (324-7629), or email him at firstname.lastname@example.org.
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