Student Loans and Bankruptcy
Lately, there’s been a noticeable change with student loans and bankruptcy. In November, the Biden team rolled out a new rule. The plans for the rule are still under review, but if fully implemented, it will make it easier to achieve bankruptcy discharge of federal student loan debt.
The change happened because new guidelines were released in the fall of 2022 by the U.S. Department of Education and the U.S. Department of Justice. They wanted to make it easier for folks struggling with student loans to get rid of their debt through bankruptcy. In the past, it was very hard, almost impossible, for people to erase their education debt in a regular bankruptcy case.
Student debt in the U.S. has become enormous, reaching over $1.7 trillion. About 7% of borrowers owe more than $100,000 each. Even before Covid-19, about 10 million borrowers were already behind or had stopped paying back their loans. [1]
What Happens to Student Loans in Bankruptcy?
Under section 523(a)(8) of the Bankruptcy Code, student loans can be discharged if the debtor shows undue hardship. The term “undue hardship” isn’t defined in the Code, but most courts follow the Brunner test.
This test requires proving three things: (i) the debtor can’t maintain a minimal living standard if forced to repay the loans, (ii) this situation is likely to continue for a large part of the repayment period, and (iii) the debtor has made good faith efforts to repay the loans. A few courts use the “totality-of-the-circumstances” test, which looks at the debtor’s past, present, and future finances, necessary living expenses, and other factors. [2] [3]
Critics of the Brunner Test
Critics note that when the Brunner test was created in 1985, student loans were only non-dischargeable for the first five years after they were due. This meant undue hardship had to be shown only if the debtor sought discharge within that period.
The Brunner test was meant to prevent recent graduates with low incomes from abusing the system. Now, this test seems too strict for those still repaying loans years or decades later. The good faith requirement, which often means consistent payments over time, can be hard to meet if the first two prongs of the test are met. [2] [4]
Circumstances of the Student
Critiques are also made against the totality-of-the-circumstances test. Some say that a borrower’s past finances shouldn’t matter; only their current and future ability to pay should. Regardless of the test used, proving undue hardship is tough. Many courts require near hopelessness for repayment, and cases that succeed often involve severe disabilities. [2]
Dischargeable Loans
Section 221(d)(1) of the tax code says that dischargeable loans can only include the cost of going to school, such as tuition, at an approved school (which can be an unaccredited school or a trade program). Private loans for extra things, like living expenses, can be canceled as well if someone files for bankruptcy. [2] [5]
Public vs. Private Lenders
There are other limits to what is considered a “qualified education loan” that can help borrowers. Importantly, it puts the burden on private lenders to prove their loans fall under section 523(a)(8). While a borrower must prove undue hardship to discharge a government loan, a private lender must take legal action to get the benefits of section 523(a)(8). [2]
Steps to File for Student Loan Bankruptcy
Filing for bankruptcy to get rid of student loans is tough and affects more than just your college debt. Here is what you need to do:
- Find a Lawyer: The first thing you need to do is find a lawyer who knows how to handle student loan bankruptcies. Not every lawyer does this, so you have to look for someone experienced.
- Seek a Consultation: Consult a lawyer. During this meeting, the lawyer can explain your options and tell you if bankruptcy is a good idea for you.
- Choose Chapter 7 or Chapter 13: You need to decide between Chapter 7 or Chapter 13 bankruptcy. These types have different rules about what stuff you can keep and what you have to pay. Your lawyer will help you figure out which one fits your situation best.
- File an Adversary Proceeding: To discharge your student loans; you have to file something called an adversary proceeding. This is like a lawsuit but happens in bankruptcy court. You will need to prove that repaying your loans would cause you undue hardship. This means showing that paying back the loans would make it really hard for you and your dependents to live. Your creditors might also come to the proceeding to argue against you.
- Wait for a Decision: There are a few possible outcomes. The court might agree to get rid of all your student loans, some of them, or none at all.
Few student loans are discharged in bankruptcy, partly because many borrowers don’t try. [2]
Frego & Associates has decades of experience helping students file for bankruptcy to get their loans discharged. Call Frego & Associates bankruptcy attorneys today.
FAQs
Yes, private student loans can be discharged in bankruptcy, but it is hard. You have to show “undue hardship” to have them discharged.
The “undue hardship” standard means you must prove that you cannot keep up a basic living standard if you repay the loans, that this situation will last for a big part of the repayment period, and that you have tried hard to repay the loans.
Most courts use the Brunner test. This test requires proving three things: you cannot maintain a minimal living standard, this situation will continue, and you have made good faith efforts to repay the loans. Some courts use the “totality-of-the-circumstances” test, which looks at past, present, and future finances, necessary living expenses, and other factors.
An adversary proceeding is a lawsuit within the bankruptcy case where you must prove that repaying your student loans would cause undue hardship. You need to present evidence and maybe face arguments from creditors.
The court may discharge all, some, or none of your student loans. The decision depends on whether you can show undue hardship and the specific details of your case.
Sources:
[1] More student loan borrowers are walking away from their debt in bankruptcy, Biden administration says. (n.d.). CNBC. Retrieved August 3, 2024, from https://www.cnbc.com/2023/11/16/more-student-loan-borrowers-walk-away-from-their-debt-in-bankruptcy.html
[2] Bankruptcy and Student Loans. (2019). In CRS Reports. https://www.everycrsreport.com/reports/R45113.html
[3] Brunner v. New York State Higher Educ. Serv. (n.d.). Case Text. Retrieved August 3, 2024, from https://casetext.com/case/brunner-v-new-york-state-higher-educ-serv
[4] Alfano, S. (2020). The High Burden of a “Minimal Standard of Living” under the First Prong of the Brunner Test. In American Bankruptcy Institute Law Review | St. John’s School of Law (Vol. 12, Issue 2). https://www.stjohns.edu/sites/default/files/2020-07/Alfano_Memo_2.pdf
[5] Limitations on Exception to Discharge of Private Student Loans. (n.d.). In Student Aid Policy Analysis. Retrieved August 3, 2024, from http://studentaidpolicy.com/fa/bankruptcylimitations.pdf