Good News out of Kansas: A compassionate bankruptcy judge grants a 59-year-old debtor a partial discharge of her student loans

The Remarkable Case of Vicky Jo Metz

Twenty-seven years ago,Vicky Jo Metz, took out $16,613 in student loans to go to community college. Over time, she paid back 90 percent of what she borrowed--almost $15,000.

But interest accrued at the rate of 9 percent, and by the time Metz came to bankruptcy court in 2018, her debt had quadruped--that's right, quadrupled--to $67,277!

Educational Credit Management Corporation, the federal government's most ruthless student-loan debt collector, opposed discharging Metz's loans.  Put Ms. Metz in a 25-year income-based repayment plan, ECMC argued.

But Kansas Bankruptcy Judge Robert E. Nugent rejected ECMC's heartless argument.  Ms. Metz is 59 years old, Judge Nugent pointed out. By the time she finishes a 25-year IBRP, she will be 84.

ECMC testified that Metz's monthly payments under a 25-year IBRP would only be $203. But, Judge Nugent observed, such a payment is about $300 a month less than the amount necessary to pay the accruing interest. Thus, after making minimal payments for 25 years, Metz would owe $152,277.88--nine times more than she borrowed.

Under the terms of an IBRP, Ms. Metz's loan balance would be forgiven after 25 years--the entire $152,000.  But the forgiven debt would be taxable to her as income. "That," Judge Nugent remarked with powerful understatement, "could generate considerable tax liability for a retired 84-year-old living on social security."

Judge Nugent sensibly concluded that Metz could not pay back the $67,000 she currently owed while maintaining a minimal standard of living. He also concluded that Metz's financial situation was unlikely to change. In fact, with very little retirement savings, Metz's income would probably go down because she would be living almost solely on Social Security in her retirement years.

Finally, Judge Nugent determined that Metz had made a good faith effort to repay her student loans. "She has paid more than $14,000 toward this loan," he noted, "not a dime of which has gone to principal."

In short, Judge Nugent summarized: "Ms. Metz will simply never be able to afford to make a significant monthly payment on her student loan." Furthermore, requiring Metz to pay the accumulated interest "would result in undue hardship to her now and in the future.

Nevertheless, Judge Nugent stated, Metz could pay back the $16,613 she originally borrowed. So this is what Judge Nugent ordered:

Rather than be yoked to a pay-as-she-earns time bomb, Ms. Metz should instead be required to pay the principal balance of the loan, $16,613.73. Doing that would not impose an undue hardship on her within the meaning of [the undue hardship standard in the Bankruptcy Code]. Therefore, that amount is excepted from her discharge in this case and the rest of her student loan is discharged. Ms. Metz should arrange to make a monthly payment that will amortize that debt over a reasonable 5 to 10-year period.

Why the Metz Case is Important

Vicky Jo Metz's case is important for two reasons. First, Judge Nugent rejected ECMC's argument, which it has made hundreds of times, that  a distressed student-loan debtor should be forced into an income-based repayment plan as an alternative to bankruptcy relief.  As Judge Nugent pointed out, an IBRP makes no sense at all when the debtor is older and the accumulated debt is already many times larger than the original amount borrowed.

Indeed ECMC's argument is either insane or sociopathic. Why put a 59-year old woman in a 25-year repayment plan with payments so low that the debt grows with each passing month?

Second, the Metz case is important because it is the second ruling by a a Kansas bankruptcy judge that has canceled accrued interest on student-loan debt. In Murray v. ECMC, decided in 2016, Alan and Catherine Murray, a married couple in their late forties, filed for bankruptcy in an effort to discharge $311,000 in student loans and accumulated interest.

The Murrays took out a total of $77,000 in student loans back in the 1990s, and they made monthly payments totally 70 percent of what they borrowed. But, much like Vicky Jo Metz, the Murrays saw their student-loan debt grow larger and larger over the years until their debt totaled $311,000--four times what they borrowed.

Fortunately for the Murrays, Judge Dale Somers, a Kansas bankruptcy judge, granted them a partial discharge of their massive debt. Judge Somers ruled that the Murrays had managed their student loans in good faith, but they would never be able to pay back the $311,000 they owed. Very sensibly, he reduced their debt to $77,000, which is the amount they borrowed, and canceled all the accumulated interest.

Conclusion

Judge Nugent and Judge Somers have grasped the essence of the student-loan crisis. Millions of Americans are seeing their student-loan indebtedness double, triple and even quadruple as interest accrues and compounds. Vicky Jo Metz, the Murrays, and people in similar positions will never pay back their massive student-loan debt.

Putting these poor souls into 25-year income-based repayment plans denies them the fresh start that the bankruptcy courts were created to provide. Under the government's income-based repayment program, this debt will be forgiven after 25 years, but the Internal Revenue Service considers the amount of the forgiven debt to be taxable income.

This is nuts. Judge Somers and Judge Nugent demonstrated compassion and common sense when they canceled accumulated interest on massive student-loan debt owed by the Murrays and Ms. Metz. Let us hope other bankruptcy judges will begin following their example.

References

In re Murray, 563 B.R. 52, 60 (Bankr. D. Kan. 2016), aff'd sub nom. Educ. Credit Mgmt. Corp. v. Murray, No. 16-2838, 2017 WL 4222980 (D. Kan. Sept. 22, 2017).

Vicky Jo Metz v. Educational Credit Management Corporation, 589 B.R. 750 (D. Kan. 2018).

The New York Times rightly criticizes Betsy Devos for rescinding DOE directive forbidding lenders from gouging student-loan defaulters: But the Times ignores the harm caused by income-driven repayment plans

A few days ago, the New York Times criticized Secretary of Education Betsy DeVos for rescinding a Department of Education directive forbidding student-loan debt collectors from gouging borrowers who default on their  student loans. Under President Obama, DOE directed the debt collectors not to assess 16 percent penalties on defaulters who quickly agreed to payment plans that would bring their loans back into good standing.

The Time is right to Criticize DeVos. As the Times pointed out in its editorial, student borrowers in the government's direct student-loan program are now defaulting at the rate of 3,000 a day. It is unjust to assess penalties against defaulters that far exceed the administrative cost of bring defaulted loans back into good standing.

But the Times rebuke went off the rails when it touted the virtues of long-term income-driven repayment plans for distressed debtors. The Times cited allegations that the lenders were not telling loan defaulters about "affordable" income-driven repayment plans (IDRs) that might cost borrowers as little as zero a month.

The Times is simply wrong to tout IDRs as "affordable." It is true that people who enter these plans may only be obligated to make token payments and perhaps no payment at all if they are unemployed or live below the poverty line.

But many people in IDRs are making monthly payments so small that the payments do not cover accruing interest. Thus their loan balances grow larger with each passing month. People in 20- and 25-year repayment plans will find they owe much  more than they borrowed when their payment obligations come to an end.

It is true that the unpaid portion of their loans will be forgiven for people who successfully complete these IDRs, but the amount of the cancelled debt is considered income by the IRS.  Under current IRS regulations, the only people who can escape that tax bill are people who are insolvent at the time the debt is forgiven.

Does that sound affordable to you?

The pitfalls of IDRs are illustrated in Murray v. Educational Credit Management Corporation, a 2016 bankruptcy court decision out of Kansas. The Murrays borrowed $77,000 in the 1990s to get undergraduate and graduate degrees, and they consolidated their debt in 1996 at 9 percent interest. Over the years, they made substantial payments. According to the bankruptcy judge, they paid $54,000 on their loans--about 70 percent of the amount borrowed.

But the Murrays' loans were put into deferment for some period of time when the couple could not afford to make their monthly payments. Meanwhile, interest accrued, and by 2015, their $77,000 debt had ballooned to $311,000--four times what they borrowed!

ECMC argued that the Murrays should be put into an IDR. The most generous plan called for monthly payments set at 10 percent of the Murrays' adjusted gross income.  Their monthly payment would then be only $635 a month, quite manageable for a couple whose joint income was approximately $95,000 a year.

But the bankruptcy judge rejected ECMC's proposal.  The judge pointed out that interest was growing at $65 a day--around $2,000 a month. Thus, the Murrays' monthly payments would amount to less than half of the monthly accruing interest. The Murrays' debt would grow to well over half a million dollars over the 20-year repayment period.

Thus, if the Murrays signed up for a 20-year IDR, one of two fates awaited them: either they would be faced with an enormous tax bill or they would be so broke their tax liability would be extinguished on the grounds of insolvency. In any event, the Murrays would be in their late 60s and in no financial shape to retire.

The Obama administration promoted IDRs and even rolled out new ones: PAYE and REPAYE. These plans give struggling debtors short-term relief, but a majority of the people who sign up for an IDR will never pay off their student loans.

Almost 6 million people are currently enrolled in one IDR or another, and most are not making payments large enough to cover accruing interest. Although  IDR enrollees are not technically in default, few will ever pay back their loans.

What is the solution for these people? There is only one solution: a discharge of their loan obligations in bankruptcy.  DOE will not admit this stark fact, and neither will the New York Times. But the bankruptcy courts are beginning to figure out that IDRs do not provide the "fresh start" that the bankruptcy process is intended to provide..  We should look for some blockbuster bankruptcy court decisions in the near future as the judges wake up to the charade of IDRs.

References

Editorial, The Wrong Move on Student Loans. New York Times, April 76, 2017.