Student Loan Bankruptcy
It is almost impossible to get rid of student loans in bankruptcy. You can’t simply declare bankruptcy and watch the student loans disappear. Student loans are not automatically included in a bankruptcy proceeding. Instead, the borrower must pursue an adversarial proceeding within the bankruptcy case, which is kind of like a lawsuit within a lawsuit. The borrower’s attorney will argue for discharge of the student loans, while the lender’s attorney argues against discharge. It may be difficult to find a bankruptcy attorney who is willing to pursue the discharge of a student loan, since it is a lot more work with little chance of success. Less than 0.04\% of federal education loan borrowers who filed for bankruptcy in 2008 obtained a full or partial discharge of their federal education loans.
The U.S. Bankruptcy Code at 11 USC 523(a)(8) excepts student loans from bankruptcy discharge, unless this “would impose an undue hardship on the debtor and the debtor’s dependents.” Unfortunately, Congress never defined what they meant by undue hardship, so the courts apply their own definitions.
The most common definitions of undue hardship include the Brunner Test and the Totality of Circumstances Test. The Brunner Test is a three-pronged test:
- The borrower must be currently unable to repay the student loan debt and maintain a minimal standard of living.
- This circumstance must be likely to continue for most of the repayment term of the loan. One bankruptcy court judge referred to this as requiring “a certainty of hopelessness, not simply a present inability to fulfill the financial commitment.”
- The borrower must have made a good faith effort to repay the debt, such as using the available options for financial relief, such as deferments, forbearances, extended repayment and income-driven repayment.
The Totality of Circumstances Test is similar to the Brunner Test but is a bit more flexible. In particular, the Totality of Circumstances Test does not explicitly include the third prong of the Brunner Test.
Because a minimal standard of living is based on the poverty line, federal student loans are usually assumed to be non-dischargeable because of the income-driven repayment plans. Likewise, the U.S. Department of Education argues that federal student loans should be excepted from discharge due to disability because of the availability of a total and permanent disability (TPD) discharge.
Yet, there may be circumstances under which federal education loans may nevertheless be discharged in bankruptcy. One must consider not just the borrower’s income, but also any necessary expenses. Examples include:
- Low income net of expenses. The borrower’s medical and disability-related expenses may be so high as to make repaying the student loans unaffordable, even if the borrower’s income exceeds 150\% of the poverty line.
- Borrower does not qualify for TPD discharge. The borrower might not satisfy the requirements for a total and permanent disability discharge, such as the poverty line earned income restriction during the post-discharge monitoring period, but still be unable to afford to repay the student loans.
- Borrower disability vs. dependent disability. The borrower may be able-bodied, but with high medical and disability-related expenses due to the disability of the borrower’s dependent(s).
- Excessive debt. The borrower’s total debt may be so high as to make the payments unaffordable, even if borrower maximized income and minimized other expenses.
- Borrower not eligible for income-driven repayment. Federal Parent PLUS loan borrowers are not eligible for income-driven repayment, except for a narrow loophole allowing a Federal Parent PLUS loan to be eligible for income-contingent repayment (ICR) if it is included in a Federal Direct Consolidation Loan. ICR might not reduce the loan burden enough to make the loan payments affordable, especially for senior citizens on fixed income.
Many private student loans do not offer a disability discharge and most do not offer income-driven repayment. This may open the door to bankruptcy discharge of private student loans when the borrower is totally and permanently disabled or has low income with no prospects for increasing income.