First Student Loan Slip Up: What to Know Before You Borrow - Financial Literacy

In high school, Bob/Bobbie Warehouser works hard for everything he gets – grades, sports, school leadership positions, community service opportunities, and summer jobs.  He wants to set himself up for a college that has a good undergraduate business school.  He says his ultimate goal is to become a social entrepreneur.  His parents can’t pay for college, so Bob takes out a student loan.

By the time he graduates, Bob has put tuition, fees, books, and room and board for his undergraduate degree on his student loan of $120,000. Bob uses $10,000 of the loan for a down payment on a new car for his part-time job.

Bob thinks that repaying his school loan, which includes the car, will not be a problem.  He expects to get a high-paying job with a prestigious consulting firm in his hometown.  The firm he has in mind hires business majors from his college who are planning to get an MBA after they work at the company for a year. Bob believes the typical, starting salary will allow him to make the $633 monthly payment on his loan, so he signs up to start repaying the loan as soon as he graduates.

Unfortunately, things do not go as Bob planned. Not only is he passed over by the big firm, he can’t find a job with another high-paying consultancy. When Bob tries to rent an apartment, the management office runs a credit check and rejects his application. That’s how he learns that he has a low credit score based on his high debt load, short credit history, and a pattern of late payments on his credit card accounts. Bob wonders if the score was a factor when he wasn’t hired by the big firms.  They must have done a credit check. With a poor credit rating, Bob is having a hard time finding an apartment, let alone a real job. 

When Bob files for bankruptcy protection, his lawyer tells him that student loans are rarely discharged in bankruptcy proceedings. That means that, despite his financial situation, he has to pay off the student loan – and that includes the Hyundai. As part of the student loan, the car obligation is not dischargeable.  According to the judge, student loans may only be discharged if they create an undue hardship for either the petitioner or his/her dependents. Bob is not married, has no children, and lives with his parents.

Finding that no undue hardship exists, the judge refuses to discharge Bob’s student loan.  That means that Bob will pay $633 per month on his student loan for the next 25 years.  Although he borrowed $120,000, because of the interest that accumulates, by the time he closes out the loan, he will have paid $190,000.  Bob realizes that by that time he will have a 25-year-old, broken down Hyundai as a reminder of his bad judgment in buying a car with his student loan.

Chapter 7: This chapter of the Bankruptcy Code provides for liquidation, that is the sale of a debtor’s nonexempt property and the distribution of the proceeds to creditors.  In order to be eligible for Chapter 7, the debtor must satisfy a means test. The court will evaluate the debtor’s income and expenses to determine if the debtor may proceed under Chapter 7.

Discharge: A discharge releases a debtor from personal liability for certain debts known as dischargeable debts.  It prevents the creditors owed that money from taking any action against the debtor or the debtor’s property to collect the money.  The discharge also prohibits creditors from communicating with him.

Discussion Starter Questions

The scenario and questions are meant to stimulate critical thinking and discussions about life decisions that may put young people on the path to bankruptcy court.

1. List Bob’s/Bobbie’s needs versus wants in this scenario. How could these wants be managed to prevent a financial crisis?
2. Identify some decision points at which Bob/Bobbie made his/her financial situation worse. How could he/she have handled each of these turning points differently?
3. What safeguards should Bob/Bobbie have put in place to protect his/her financial stability — and avoid the risk of facing bankruptcy?
4. What are some financial setbacks/surprises that Bob/Bobbie should anticipate and prepare for in his/her teens, 20s and 30s?
5. When Bob/Bobbie realizes he/she is in trouble, what are some steps to take to put on the brakes?
6. What are some factors a judge may consider when deciding whether Bob/Bobbie will keep his/her vehicle (motorcycle, truck, and car)?
7. Given this scenario, can student loans forgiven?
8. What kinds of debts cannot be discharged?
9. What are some of the short-term and long-term impacts on someone’s professional and personal life that stem from filing for bankruptcy protection?
10. What are some typical, student spending habits that can put someone’s future in jeopardy?

Examples of Responses to Discussion Starter Questions

The general approach taken in these responses can be used with each of the scenarios.  The boldface type identifies the point of each question. 

1. Needs v. Wants. Using this scenario as a springboard for differentiating between basic needs and wants, students are asked to identify both. Among the needs that students are likely to find in any scenario are rent, transportation, basic living expenses and financial obligations, including student loans, car payments, and monthly bills.
   
   The protagonist’s wants are easy to identify. Some of the ways to manage finances and prevent a financial meltdown include creating and maintaining a budget, building in spending for entertainment and travel, etc.  The protagonist also could have scaled down her current spending and set short-term and long-term financial goals.
    
2. Decision Points. Some points at which protagonists can make their financial situation worse include the following:
   1. Deciding to buy everything, or to buy expensive items all at once, rather than developing a scaled-down, incremental plan;
   2. Putting optional expenses on a credit card;
   3. Charging more than what could easily pay off in one billing cycle;
   4. Accumulating too many credit cards;
   5. Maxing out the credit card limits; and
   6. Only making the minimum monthly payment on each card.
       
3. Safeguards. To protect finances, some safeguards that could be put into place include:
   1. Establishing a budget that includes spending money;
   2. Setting up automatic savings from paychecks; 
   3. Building up a cash reserve to cover living expenses for six months to provide a safety net; and
   4. Building up an emergency fund.
       
4. Anticipation. Some financial challenges that should be anticipated and prepared for at this stage in the teen years, 20s and 30s include saving to create an emergency found that will cover: 
   1. A long period of unemployment during job searches;
   2. Getting a job and establishing a work-appropriate wardrobe;
   3. Working part time or being under employed;
   4. Being financially self sufficient;
   5. Getting a car;
   6. Getting an apartment (deposit, plus first and last month’s rent).
       
5. Brakes. When the protagonist in the scenario realizes he/she is in financial trouble some steps can be taken to put on the brakes.  They include:
   1. Cutting up credit cards but not closing accounts;
   2. Scaling down the standard of living;
   3. Getting a roommate;
   4. Getting a second job, even if it is only occasional work.
       
6. Car Debt. If it is determined that the protagonist can continue making car payments after discharging the credit card debt, the car note, sometimes, can be reinstated so that the car can be kept.
    
7. Student Loans. The protagonist, probably, will not be able to get student loans discharged. Such debts are not discharged unless the debtor can prove that repaying the student loans would impose an undue hardship on the debtor.
    
8. Nondischargeable Debts. In addition to student loans, other debts that cannot be discharged include:  
   1. Income taxes for the three years preceding the bankruptcy filing
   2. Fraudulently incurred obligations (that is, providing a creditor, such as a credit card company, with false or incomplete financial statements)
   3. Certain domestic obligations, such as child support and alimony
   4. Debts arising from the debtor's willful and malicious injury of person or property
   5. Personal injury obligations incurred as a result of the debtor's driving while intoxicated.
       
9. Impact. 
   1. Some of the short-term results of filing for bankruptcy might include:
      1. Protection of assets from collection
      2. The establishment of a repayment plan that is less burdensome.
      3. The possibility that -- after a set number of months of reliable payments are made — the remaining debts may be discharged.
   2. Some of the long-term consequences that are less favorable might include:
      1. Bankruptcy damages a credit rating for 10 years.
      2. It also will jeopardize opportunities for renting an apartment, landing a job; getting a mortgage; or getting into a serious personal or business relationship.
          
10. Self-Awareness.  Students discuss spending habits that could get them into financial trouble, e.g. using credit cards for consumables – food, cosmetics, etc.