By Austin Smith | March 18, 2019
There is a great deal of misinformation surrounding student loans in bankruptcy. Most people believe that anything called a “student loan,” or any debt made to a student, cannot be discharged in bankruptcy. This notion is fundamentally untrue.
And to make matters worse, we’ve seen new evidence that one of the largest creditors in the student loan market, Navient (formerly part of Sallie Mae), has been misleading borrowers across the country about this fact, even as it comes clean with its investors.
Before we get to the scandal, here is some background: we must point out that “most” student loans are only dischargeable in bankruptcy under extraordinary circumstances (known as “undue hardship”). But that is simply because most student loans are guaranteed or insured by the federal government, which federal bankruptcy law has treated differently for decades. Private student loans, on the other hand, are only held to this high standard if they are “qualified education loans.” And not every loan a borrower thinks is a student loan meets this test.
So what exactly is a “qualified education loan”?
Qualified education loans are defined in both the Tax Code and the Higher Education Act as debts incurred solely to pay for (i) qualified higher education expenses (ii) at an accredited institution by (iii) an eligible student. Qualified higher education expenses are defined as the “cost of attendance” which is a sum determined by the institution, to cover tuition, fees, room, board, and books.[1] Basically, this means you and your loan must have three characteristics:
- Eligible School: You must have borrowed the money to attend a Title IV eligible school. If your school did not offer federal student loans, it’s more than likely your school was not Title IV accredited, and thus any debt you incurred is not a “qualified education loan.” To be sure, check your school against the Department of Education’s Title IV eligible school list for the year in which you attended. If the school does not appear, the school was not Title IV eligible, and the loan could not be a qualified education loan.
- Eligible Money: You must have borrowed money within the school’s published “cost of attendance.” Check your school’s “cost of attendance” and compare that to the total of amount of money you received from all federal, state, and private sources, including scholarships, grants, work-study, and loans. If you borrowed even one dollar more than was necessary to cover the“cost of attendance,” the private loan was potentially not incurred solely to pay for qualified higher education expenses and is not a qualified education loan.[2] Anyone who attended college between 2004 and 2008 should be highly alert to this issue. During that time, many lenders were making what were called “direct to consumer” loans, which bypassed the financial aid office and lent money directly to students. So if you recall receiving checks directly from a student lender, it’s very likely that you were borrowing in excess of the “cost of attendance” and at least some of your private loans are not “qualified education loans.
- Eligible Student: Unless you were studying half-time or more, it’s likely that you were not an “eligible student” under the Higher Education Act. So if you were studying only a night, or only on the weekends, be sure to find out if your private loans were incurred during a period of time when you were less than half-time (which is generally considered less than 6 credits per semester). If you were not an eligible student, then you could not have borrowed a “qualified education loan.”
It is worth noting that the student loan industry is perfectly aware of this distinction. In fact, since at least 2006, private student lenders have been bundling these debts and selling them to investors—investors who were warned up front that some of the student loans contained in these trusts may be dischargeable in bankruptcy after all. Consider the following disclosure that the private student loan company Sallie Mae made to investors:
“Risk of Bankruptcy Discharge of Private Credit Student Loans: Private credit student loans made for qualified education expenses are generally not dischargeable by a borrower in bankruptcy . . . direct-to-consumer loans are disbursed directly to the borrowers based upon certifications and warranties contained in their promissory notes, including their certification of the cost of attendance for their education. This process does not involve school certification as an additional control and, therefore, may be subject to some additional risk that the loans are not used for qualified education expenses. If you own any notes, you will bear any risk of loss resulting from the discharge of any borrower of a private credit student loan to the extent the amount of the default is not covered by the trust’s credit enhancement.”[3]
Note what Sallie Mae is saying here. They are saying that despite the warranties and certifications made in the promissory notes, some of the loans may have been made for expenses other than qualified higher education expenses.
Where that happened, the debt may be discharged in bankruptcy after all, just like credit cards and other consumer debts.
Navient has also warned its investors that all “Career Training” loans are dischargeable in bankruptcy. Career Training loans are made to trade schools, vocational schools, and high schools, most of which are not accredited by the Department of Education, and thus are not “eligible schools”:
“Risk Of Bankruptcy Discharge Of Career Training Loans: Career training loans are generally dischargeable by a borrower in bankruptcy. If you own any notes, you will bear any risk of loss resulting from the discharge of any borrower of a career training loan to the extent the amount of the default is not covered by the trust’s credit enhancement.”[4]
But these same student loan companies routinely tell their customers that student loans cannot be discharged in bankruptcy, both in loan contracts and in phone calls with their customers.
As you can see, the student loan industry has dug itself into a hole. At the same time that it has been telling student borrowers that no student loan can be discharged, it has been telling its investors the opposite.
Yes, that’s misleading.
Yes, that’s potentially fraudulent conduct.
Yes, big student loan companies will try to find a way to try to explain how these two statements are not really contradictory. Borrowers should beware.
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Austin Smith is a litigator at Smith Law Group, LLP, who focuses on discharging student loans in bankruptcy. Mr. Smith’s article, The Misinterpretation of 11 USC 523(a)(8), was foundational in articulating the proper scope and application of the student loan non-dischargeability provision of the Bankruptcy Code, and its arguments and reasoning have been adopted by bankruptcy courts all across the country. Mr. Smith’s work on behalf of debtors has been profiled by the Wall Street Journal, NPR, ABC News, Fox News, People Magazine, GOOD Magazine, the National Law Journal, Law 360, the American Bankruptcy Institute, and more.
[1] See 20 U.S.C. § 1087.
[2] See IRS, 26 C.F.R. 1, REG-116826-97 (“Student I signs a promissory note for a loan which is secured by I’s personal residence. Part of the loan proceeds will be used to pay for certain improvements to I’s residence and part of the loan proceeds will be used to pay qualified higher education expenses of I’s spouse. Because the loan is not incurred by I solely to pay qualified higher education expenses, the loan is not a qualified education loan.”).
[3] See SLM Loan Trust 2008-1 Prospectus Supplement.
[4] See Navient Private Education Loan Trust 2014-CT, Offering Memorandum.