Discharging student loans in bankruptcy occurs only as an exception to the rule. Chapter 7 bankruptcy discharges garden variety unsecured debt, largely credit cards. But, student loans are different.
To discharge student loans there must be proof that payment imposes an undue hardship as defined in bankruptcy law. Many courts follow a three part test:
To Establish “Undue Hardship” Need All Three:
- The debtor cannot maintain a minimal standard of living if forced to repay the student loan, based on current income and expenses;
- Additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the loan;
- The debtor has made good faith efforts to repay the loan.
Take the case of a lawyer who graduated from law school owing $360,000 in student loans. In the five years after graduation he worked as a law clerk, a legal services attorney, and a contract attorney with a temp agency. Gross annual income at the time of the bankruptcy filing was $48,000. He claimed that student loans, coupled with child support and tax payments created an undue hardship.
Characterizing the debt as “shockingly immense”, the Bankruptcy Court found an undue hardship and allowed discharge. But the appeals court reversed, finding the hardship caused at least in part by the debtor’s self-imposed limitations, quitting every job he’d ever had. Further, he failed to apply for available federal loan repayment assistance, which the court concluded could have made the loans affordable while maintaining a minimal standard of living. (ECMC v. Jesperson, 8th Circuit Court of Appeals, 2009.)
Student loans were discharged in a case in which the debtor took out loans to attend a technical school where he got a certificate as “associate of specialized technology.” The certificate was not accepted by other colleges, didn’t help at work and never brought increased earnings. The debtor’s wife suffered from a serious permanent mental illness found likely to interfere with her ability to work.
Finding good faith, where initial attempts were made to pay, the court allowed discharge of nearly $10,000. But, that case is peppered with unique facts. (In Re: Pena, 9th Circuit Court of Appeals, 1997.)
Legal Standard to Discharge Student Loans: Hopelessness
“Hopelessness for the indefinite future as to any possibility of repayment” is how the New Hampshire Bankruptcy Court described circumstances that must exist. A culinary arts technical school graduate faced $40,476 in student loans. Some had been “accelerated” with demands for immediate payment. The debtor’s annual gross salary of approximately $30,000 was earned largely as an assistant culinary arts instructor. In a detailed analysis the court found no ability to cut expenses. (Kainu v. Sallie Mae, U.S. Bankruptcy CT., Dist NH, 2009.)
Discharging student loans is the unusual exception. It does not happen as a matter of course in the standard discharge. The issue must be raised in an adversary proceeding filed in the federal bankruptcy court. Often highly contested, the question ultimately is litigated and determined by a federal judge.
However, for many saddled with student loans, getting all the rest of the debt discharged in a chapter 7 will “free up” cash flow to address the student debt load. Plus, forestallment and student loan consolidation can be additional strategies.