Should I file bankruptcy or try debt settlement?

Dear Liz: My question is whether I should file for bankruptcy or try to settle my debts.

I owe about $50,000 on credit cards, $120,000 in student loans and $701,000 on my home. I have stopped paying on my credit card debt because my issuers increased their rates and were unwilling to work with me, so I am unable to pay even the minimums they now require. My mortgage is being modified, although it has been four months since the process started and I have received a notice of default, which is the first step in the foreclosure process.

I am unsure what to do, but I do know I don’t have anywhere else to go. I have to provide a safe haven for my children and disabled parents. What’s your advice?

Answer: You need to talk to a bankruptcy attorney, pronto.

That doesn’t mean filing for bankruptcy will necessarily be the right choice. You won’t be able to eliminate your student loan debt. If your income is too high, you’ll be put on a payment plan instead of being able to erase the credit card debt.

But it may well be the best of bad options. Debt settlement is typically available only for credit card debt, and you would need a sizable lump sum of cash to persuade your issuers to negotiate.

And even if you get a mortgage modification, your housing problems may not be solved. Borrowers too often agree to a modification of a debt that never has been, and never will be, affordable. That’s why so many mortgage modifications have resulted in default and foreclosure.

What you need is an educated third party to look at your finances and explain your options to you.

Ivy League tuition-waiver doesn’t apply to our “dream school” applicant

Dear Liz: You recently mentioned a study by Alan Krueger of Princeton University and Stacy Dale of the Mellon Foundation. You correctly state the main result of this study without reporting an important secondary finding that contradicts your advice. Yes, Krueger and Dale found that students who were accepted at a highly selective college but chose to go elsewhere did just as well in life as those who went to a highly selective college.

But they also reported an important exception: students from lower-income families, whose earnings were substantially greater if they went to the highly selective college. Since students from lower-income families are precisely the students most likely to need loans to attend college, it follows that for them taking out loans to attend a highly selective college would be a good investment.

Do you think Supreme Court Justice Clarence Thomas or nominee Sonia Sotomayor would be where they are now if they hadn’t accepted the financial and academic challenge of attending highly selective colleges?

Answer: You make a good point about the study, but it doesn’t fit today’s financial aid realities. The person who wrote asking for advice had been accepted to her “dream school” but faced the prospect of borrowing to pay for most of her school expenses. That indicates either that she was not from an economically disadvantaged background or that it wasn’t an Ivy League school that accepted her.

Many Ivy League schools now waive tuition entirely for low-income students, and others provide enough in grants to minimize the need for loans, particularly the pricey private loans that she would have to tap once she exhausted low-rate federal loans.

So my advice remains the same. Rather than borrow $200,000 to pay for an undergraduate business degree, with the likely prospect of borrowing more to get her MBA, she would be better off pursuing an affordable undergraduate education and then borrowing to attend a “dream” graduate school. Sacrificing to attend college is one thing. Lashing yourself to a lifetime of expensive debt is quite another.

Student loan settlement won’t be cheap

Dear Liz: I was disappointed with your answer to the person who wanted to settle student loan debt for less than what he owed, even though he had a windfall that would allow him to pay the balance in full. This person presumably benefited from the education that these loans provided and now could afford to pay them back. Why did you offer advice that would allow him to avoid that responsibility?

Answer: As you’ll recall, the writer originally borrowed $50,000 in federal student loans almost two decades previously but had received an annual forbearance ever since. Forbearance indicates the writer suffers some kind of ongoing, demonstrable hardship such as poor health, partial disability or inadequate income.

The unpaid balance had swelled to $155,000 because of interest and fees. Although the windfall would allow him to pay the debt in full, it wasn’t clear whether the problem that caused the need for the forbearance had disappeared. If not, then conserving some of the windfall might be a prudent option.

There are those who believe that paying the full balance of any debt is a sacred obligation, no matter how much damage such an action may do to a person’s financial future. Others would allow that there are shades of gray and that past and future obligations must be weighed against each other.

In any case, the writer isn’t going to be able to settle the debt for pennies on the dollar, as he might be able to do with other bills, such as credit card debt. Settling student loan debt is tough, because the Department of Education has many tools to force borrowers to pay.

As the previous column noted, what the department might be willing to do is forgive some of the accumulated interest and fees, according to student loan expert Mark Kantrowitz of FinAid (www.finaid.org).

Kantrowitz’s advice was to find out how much the department paid to acquire the loan when it was consolidated, offer to split the difference between that figure and the current balance, and then accept the department’s counteroffer.

Is a “dream school” worth any price?

Dear Liz: This is regarding your advice to the would-be business major who was accepted at her dream college but who wasn’t offered much financial aid. I was dismayed that you suggested trading down without even knowing which college accepted her. If indeed she got into an Ivy League school, she would be crazy to give up the opportunity. If she is capable, she will be earning millions over a 40-year career. The $200,000 cost of her school would be a drop in the bucket compared with that. The top-tier schools in reality provide more opportunities for both graduate school and career advancement. It is all about “option value,” and these schools provide the greatest upside.

Answer: You may be overestimating the value of an Ivy League education. You’re certainly underestimating the risk of shouldering $200,000 in loans for an undergraduate degree.

A study by a Princeton economist found that those who are accepted at Ivy League schools, but who opt to study elsewhere, do just as well in life as those who graduate from top-tier schools.

If she stuck with her dream school, our student would quickly exhaust the low, fixed-rate federal student loans available to her. The maximum she could borrow under federal student loan programs would be $31,000. That means she would need to turn to private student loans, which tend to have variable rates that currently average around 12% and which have no caps.

Using private student loans to finance an education is equivalent to using credit cards — except unlike credit card debt, student loan debt generally can’t be erased in Bankruptcy Court.

A wiser course for this business major might be to find a more affordable undergraduate education and then seek out a brand-name MBA program. The return on that investment probably would be high enough to justify the cost.

Settling student loan debt: tough, but possible

Dear Liz: I currently have a consolidated student loan with the federal Direct Loan program at an 8.25% fixed rate. I initially borrowed $50,000 18 years ago, but the balance due has ballooned to almost $155,000 over the years.

I have annually applied for and been granted a forbearance from Direct Loans so my account is currently in good standing. I’ve recently had some good fortune and will be coming into a substantial amount of money that would allow me to pay off the entire balance due in one payment.

Given the circumstances, is it possible for me to approach Direct Loans with the possibility of paying off the entire balance due at a reduced rate since I’m willing to pay it all up front? For instance, I could offer them $100,000 if they’ll forgive the remaining balance of $55,000.

Answer: In most cases, the U.S. Department of Education won’t negotiate with borrowers over the amount they owe on federal student loans, said student loan expert Mark Kantrowitz of FinAid.org.

That’s because the department has extraordinary powers to force you to pay. The debt can’t be discharged in bankruptcy and the department can intercept tax refunds, garnish your wages and take a portion of many government benefits, including Social Security checks, if you default.

There also is no statute of limitations on student loan debt, which means there’s no time limit on how long the government can take to sue borrowers who default. The feds can wait for years until borrowers’ circumstances improve and then go after them.

Given its arsenal, the government can take a tough stance, Kantrowitz said. But he has heard that the department sometimes will agree to forgive a portion of accrued interest and fees if the remaining balance will be paid off in full.

What you need to find out is how much the Direct Loan program paid for your loan, Kantrowitz said, since the government will never accept less than what it cost to acquire a loan.

You’ll need to use the National Student Loan Data system ( www.finaid.org/loans /lostlender.phtml) or your own records to determine what your balance was when you consolidated your loans into the Direct Loan program. That is the amount the department paid to acquire the loans from your original lender.

Kantrowitz recommends offering to split the difference between that figure and your current balance. Whatever the department counteroffers, accept it.

“That’s a reasonable approach that is fair to both the borrower and the taxpayers,” Kantrowitz said, “providing the taxpayers with some compensation for the cost of the funds over the years.”

Don’t spend the rest of your windfall, however. If the government does forgive a portion of the debt, the amount forgiven is considered taxable income to you.