Proposed student-loan rule changes could benefit bankrupt borrowers

If anyone seemed to have a valid excuse for not repaying his student loans, it was this 25-year-old Chicago man, battling a mental illness and unable to hold a job.

Like other college graduates who have tried to escape his school debts, this man (who did not want to be named for this story) was unable to wipe away his financial obligation by declaring bankruptcy. Struggling with schizophrenia for years, he decided to go to college and try to get a good job in an effort to win some normalcy. He applied for, and received, about $39,000 in private and federal school loans and was able to make it through four years at a university because he was able to concentrate in short bursts.
But once he tried to hold a job at a series of manufacturing and other blue collar posts, he found that his mental illness intruded on his thoughts and couldn't stay focused. He was fired again and again. Today, the man is depressed and trying to figure out what to do with the rest of his life. And he's attempting to get part of his student loan debt voided through a non-bankruptcy hardship clause available through one of the lenders.

His story illustrates just how difficult it can be to use bankruptcy as a last-ditch effort to avoid repaying loans taken out to further one's education.

Collecting just $6,500 a year in disability payments, he could not afford a place on his own, or much else, and lived with his parents. But with school debts accruing and collectors pursuing repayment with almost daily calls, he felt he had no other choice than to declare bankruptcy. Chicago bankruptcy attorney David Siegel, who's been in practice 19 years, agreed to take on the man's case, even though he knew how unlikely it was he would win a reprieve because of the stringent requirements for proving undue hardship. One of the few ways to show undue hardship is if you are unable to support yourself due to an illness or disability you have no reasonable expectation for recovery, Siegel said, adding, "I felt this one had a chance to succeed."

But because the man already had been diagnosed with schizophrenia at the time he applied for the loans and was unable to find a doctor to say the condition had gotten worse, his claim was denied.

Now, however, some members of Congress are proposing changes to bankruptcy laws that would give a break to people with private student loans -- typically from such lenders such as Sallie Mae or Citibank.

Currently, people filing for bankruptcy can have debts for items such as credit card balances, gambling losses, mortgages and car loans wiped out, or "discharged." But they are still generally responsible for other bills, such as child support, criminal fines and student loans, unless they are able to prove "undue hardship," a difficult legal standard which few have been able to overcome.

The new law would allow private student loans to fall into the category of debts that can be more easily discharged, as they had been before a 2005 revision in bankruptcy law. (Federal student loans, such as Stafford and Perkins, would not be affected by the proposed bankruptcy legislation and would continue to require repayment).

Sallie Mae says it does not ask potential borrowers about their mental (or physical) status and "has every incentive to help our customers successfully manage their loans," according to spokeswoman Patricia Nash Christel. She added that, "the overwhelming majority of our customers successfully manage their private student loans" -- the most recent default rate is 4.7%. Whether to allow the undue hardship exception is up to a bankruptcy court, not Sallie Mae, she said.

Siegel -- who believes that lenders will stop pursuing the Chicago man if he continues to have a very limited income -- warns other student borrowers to read the fine print of their loan documents and truly be aware of the repayment responsibilities, particularly because he doubts the new legislation will pass.

"Students who receive the benefit of an education," he said, "should plan on being required to pay back student loans."

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