Student Loan Discharge in Bankruptcy
The average student loan debt is $40,000, amortized over 30 years. Many debtors are forced to make monthly payments in excess of $1,000, which is comparable to a mortgage payment. Bankruptcy laws were enacted to provide assistance to people suffering from overwhelming financial debt, but little help is offered to those burdened with student loans.
Student loans are extremely difficult to discharge through bankruptcy. Under Chapter 7 bankruptcy, essentially all debts are discharged, with the exception of student loans and other debts such as support obligations or recent taxes. A debtor seeking discharge of a student loan must prove that payment of the debt will impose an undue financial hardship.
Most Bankruptcy courts apply the Brunner test to determine the discharge of student loans. The Brunner test, based on a 1987 U.S. Court of Appeals decision, sets forth three criteria to measure undue financial hardship:
• The debtor will be unable to maintain a minimal standard of living, based on current income and expenses, if forced to repay a student loan.
• Circumstances exist indicating that the debtor’s financial situation is likely to continue for a significant portion of the student loan repayment period.
• The debtor has made good faith efforts to repay or renegotiate the terms of the student loan.
Since the Brunner decision was rendered, undue hardship has become the only factor considered in a bankruptcy discharge of student loans. Bankruptcy courts may interpret the criteria of the Brunner test differently. Some courts view a minimal standard of living as below the federal poverty level, which makes it increasingly difficult for a debtor to prove undue hardship. After a debtor has exhausted all attempts at increasing income and reducing expenses to a bare minimum, student loan lenders continue collection efforts.
A bankruptcy discharge of student loans involves an adversary proceeding, which is separate from the bankruptcy case. During the proceeding, some courts use a “totality of circumstances” test for determining undue hardship. Under this test, the courts evaluate the following factors:
• the debtor’s current and future ability to pay the student loan;
• whether the debtor has made a good faith effort to negotiate a deferment or forbearance;
• whether the debtor’s financial hardship is likely to be a long-term situation;
• the debtor’s payment history on the loan prior to default;
• whether the debtor suffers from a serious illness or permanent disability;
• the debtor’s ability to obtain gainful employment in his or her field of study;
• whether the debtor has attempted to increase income and significantly reduce expenses;
• whether the debtor’s primary purpose in filing for bankruptcy is based solely on the discharge of student loans; and
• the ratio of student loan debt to total debts.
If a debtor is able to convince the court that he or she suffers from undue hardship, student loans can be discharged in Chapter 7 bankruptcy. In the unfortunate event that a debtor’s student loans are not discharged, private lenders may be willing to negotiate a reasonable payment plan based on the debtor’s current income. Private lenders may waive penalty charges and late fees. It may be possible to negotiate a lower interest rate and extend the term of the loan, which would reduce the monthly payment.
Federally-funded student loans are the most difficult to discharge in bankruptcy. Federal collection agencies have the power to seize tax refunds, garnish wages, bank accounts and federal benefits, such as Social Security. Bankruptcy courts will not discharge federal student loans unless special circumstances exist. Since there is not a statute of limitations on federal loans, collection efforts can continue throughout the life of the debtor.
A debtor with a regular monthly income may be better served by filing a Chapter 13 bankruptcy. Under this type of bankruptcy, student loans are treated the same as all debts. The debtor makes one monthly payment to the court, which is distributed proportionally among all creditors. Under Chapter 13, the debtor can either continue paying his monthly payment towards the student loan or treat the student loans similar to all other unsecured debts, such as credit card debt. If the chapter 13 plan does not pay anything to unsecured creditors, nothing will be paid to student loans. Following completion of the payment plan, student loans are still owed and collection efforts may resume. After completion of a Chapter 13 plan, it may be possible to renegotiate the terms of the remaining balance. In the alternative, a debtor can attempt to discharge the remaining balance based on undue hardship. Under the Brunner test, completion of a Chapter 13 reorganization plan satisfies the good faith effort to repay the student loan.