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Bankruptcy and Student Loan Debt

The majority of debtors will not succeed in having their student loans discharged when they file for Chapter 7 or Chapter 13 bankruptcy. If you are able to prove that having to repay student loans would create an undue hardship on you, however, you might be able to wipe out your student loan debt in bankruptcy.

What Is Undue Hardship?

Student Loans BankruptcyTo be able to get student loan debt discharged in bankruptcy, you’d have to show that for you to pay them would create an “undue hardship” on you. Thus, the undue hardship test is used to determine whether your student loans can be wiped out, and the test may differ in form from court to court.

However, no matter which form of the undue hardship standard your court applies, the majority of courts are very hesitant to discharge a person’s student loan debts. But if you are a particularly low-income individual, or if your loans were incurred at a trade school which is not for profit, you might have a chance at having the loans discharged.

The Brunner Test

Other bankruptcy courts will use what is called the Brunner test. Using this test, a person may succeed in having their student loan debt discharged so long as they satisfy each of these three requirements:

  • Poverty: This requirement is met if, based on your income and current expenditures, you would be unable to maintain at least a minimal standard of living for you and for any dependents you may have if you were made to pay back your student loans.
  • Persistence of your current financial state: If it is likely that your present financial situation will continue for a substantial portion of the loan repayment period.
  • Good faith: You will satisfy this requirement if you have put forth a good faith effort to repay the student loan debts.

The Good faith element is particularly hard to satisfy because it require that the debtor have attempted to repay the student loan debts. Thus debtors with long periods of non payments on their student loans may not qualify under the Brunner test. Courts within the 10th circuit have indicated that good faith means that the debtor has attempted to pursue non-bankruptcy measures for their student debt like the income contingent repayment plan or the income based repayment plan.

Totality of the Circumstances Standard

Some courts may apply a “totality of the circumstances” test instead (please note that New Mexico is part of the 10th circuit and at the time of this writing follows the Bruner Test). Using the Totality of the Circumstances test, the court will examine all relevant factors in your case, without a set list, to assess whether an undue hardship would be created if you are made to repay your student loans.

Note:  Some courts use a special test for Health Education Assistance Loans (HEAL), under which you will be required to show that your loans became due over seven years ago, and that presently, repayment would create an “unconscionable” burden on you.

Discharging a Portion or All of Your Student Loans

Numerous courts will regard the undue hardship test as all or nothing. Using the test, the court will usually find that you either qualify to have your entire loan discharged, or you do not qualify to have any portion of the loan discharged whatsoever. Alternatively, other courts might be willing to discharge only part of your debt, without letting you off the hook for the full amount.

Procedure for Discharging Your Student Loans in Bankruptcy

If you plan on trying to have your student loans discharged in bankruptcy, you will need to file a formal complaint with a bankruptcy court (this requires filing an adversary proceeding). This complaint is called a Complaint to Determine Dischargeability, and once it is filed, it will then be your responsibility to prove to the bankruptcy court that if you were forced to repay your student loans, you would be faced with an undue hardship.

Defenses That Can Be Raised to Student Loan Debt in Bankruptcy

You might have a defense against being forced to repay your student loan debt, especially if you incurred the debt at a vocational or trade school. For example, you might succeed in raising a defense of breach of contract, fraud, or unfair/deceptive business practice. These defenses can be raised in a creditor’s Proof of Claim. If you are successful with one of these defenses, you will not need to pay the loan debt at all, which will render the issue of the debt’s dischargeability irrelevant.

Consider Consulting an Attorney

There are many court cases in which a court has used the Brunner test or some other standard with regard to Chapter 7 debtors seeking to discharge their student loans. If you know what the court in your jurisdiction has done previously with cases that may be similar to your own, it could increase your chances of a favorable outcome. If you have a large amount of student loan debt and you have not yet consulted with an attorney, it is probably worth the time to consult with a bankruptcy attorney in your area about the issue. Also, if you should decide to take the matter to court, you will probably need a bankruptcy attorney’s representation.

What If Your Student Loans Are Not Discharged?

In the majority of cases, a person’s student loans will not be dischargeable. If this is true in your case, here it what will happen after the court finds that your loans cannot be discharged:

In Chapter 7 bankruptcy: With Chapter 7 bankruptcy, you will be made to repay your loans once your bankruptcy case concludes, unless doing so would cause undue hardship.

In Chapter 13 bankruptcy: If your loans cannot be discharged, Chapter 13 bankruptcy actually offers other ways that may be helpful. For example, you might be permitted to pay a reduced amount of repayment during your Chapter 13 plan, though you will remain liable for the amount remaining at the end of that period. So, you will end up repaying the full loan, but with more time.

More Options for Dealing with Student Loans

Luckily, there are a few non-bankruptcy options available to those individuals who are dealing with student loan repayment, including reducing payments, and in some cases, even cancelling payments (here is more information about non bankruptcy options: income contingent repayment plan and income based repayment plan).