The Hardship Discharge for Student Loans

The Limited Circumstances Where You Can Discharge Student Loan Debt in Bankruptcy

Student with tabletIf you have overwhelming debt from financing a college education, you are not alone. According to recent studies, the average amount of debt college graduates face now exceeds $30,000. More than seven out of every ten graduates will have some type of debt. The average total student loan bill for graduates of for-profit colleges is nearly $40,000.

If you haven’t found a job that will allow you to repay that student debt, you may have considered bankruptcy as a way to get a fresh start. Unfortunately, it’s extremely difficult to discharge most student loan obligations in bankruptcy. Most, but not all “student loans” are made non-dischargeable unless you can prove “undue hardship”, which as we will see is a difficult test to pass.

Before we get to what you have to prove to get a student loan discharged, let’s clarify that not every loan which is used for education is made non-dischargeable. “Student loans” are those which were

  1. made, insured or guaranteed by a federal, state or other governmental unit;
  2. made under a program funded by a governmental unit or non-profit institution; or
  3. otherwise meet the tax qualifications for a “qualified education loan”; or
  4. arise from an overpayment of a scholarship, grant, stipend, or other educational benefit.

So the starting point is to find out what type of loan you have. Hopefully you saved or can get the loan papers. If your debt fits into one of the above categories, here’s what you need to demonstrate to have a chance of ridding yourself of student loan debt in a Chapter 7 proceeding.

The Undue Hardship Discharge

Under the generally-recognized “Brunner test” (named for a Supreme Court decision of that name, you must prove:

  • The you lack the financial resources to pay student loan debt and maintain a minimum standard of living
  • That you have tried, in good faith, to repay student loans
  • That there is no expectation that your financial situation will change for the foreseeable future

The determination that you lack the financial resources to repay student loans and have the basic needs of life is decided on a case by case basis, and can vary substantially. While the courts don’t necessarily require that you have no discretionary income, at least one court has held that a disposable income of less than $200 per month after expenses was not an undue hardship. It is a very hard test to meet.

New Jersey and Pennsylvania bankruptcy courts generally follow the Brunner test. Some other courts have applied what is called “the totality of the circumstances,” examining income, expenses, spending habits and other factors to determine whether the payment of student loan debt constitutes a dischargeable hardship.

The majority of courts hold that you must either discharge all of your student loan debt or none of it. Some, though, have approved or required a partial discharge of student loan debt based on hardship.

We recommend that clients with non-dischargeable student loans look into non-bankruptcy alternatives, including income-based repayment plans, and programs that discharge the loan after a period of time. These exist for federal loans, but not New Jersey state loans. In some cases, these valuable rights can be lost by use of a loan consolidation.

Another option is to use bankruptcy. While student loans may not be dischargeable, other debts may be, thus freeing up income to pay the student loans. We have also used Chapter 13 to create a five-year payment “breather” in which student loans get partially paid through the plan. While any unpaid balance on the student loans will still be due at the end of the plan, the “breather” can help get things back on track.

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