If you are struggling with student loan debt, you may have been told that bankruptcy is not an option because student loans cannot be discharged. That is not entirely true.
Student loans are generally excepted from the general discharge in bankruptcy, which makes them more difficult to discharge than many other debts. However, bankruptcy provides a pathway for borrowers to seek a discharge when repayment would impose an undue hardship.
The important distinction is that student loans do not simply disappear when you receive a bankruptcy discharge. Unlike most debts, you generally must take an additional step and ask the bankruptcy court to determine whether your student loans qualify for discharge.
Why Don’t Student Loans Automatically Discharge in Bankruptcy?
When you file bankruptcy, many unsecured debts will eventually be discharged. Student loans are treated differently.
Under Section 523(a)(8) of the Bankruptcy Code, certain student loan obligations generally remain enforceable unless the borrower establishes that repayment would cause an undue hardship.
This creates an important difference between student loans and many other debts.
For most debts, a debtor receives a discharge without having to prove individually that each debt is dischargeable. If a creditor believes that a particular debt should not be discharged, the creditor must take steps to challenge it in the court.
Student loans, however, is different. If you want your student loan debt discharged based on undue hardship, you generally have to take the initiative. This usually means filing an adversary proceeding, which is a separate lawsuit within the bankruptcy case.
What Does “Undue Hardship” Actually Mean?
There is no specific income level, debt amount, or monthly payment that automatically qualifies as an undue hardship.
Instead, the bankruptcy court examines the borrower’s individual circumstances.
In New York and New Jersey, courts generally apply the three-part test associated with the Brunner standard. The court considers (1) whether requiring the borrower to repay the loans would prevent the borrower from maintaining a basic standard of living, (2) whether the borrower’s financial circumstances are likely to continue, and (3) whether the borrower has made good-faith efforts to repay the debt.
This is not a mathematical test. For example, two borrowers could each earn $100,000 per year and owe the same amount in student loans, yet have completely different outcomes. One borrower may have significant medical expenses, dependents, high necessary housing costs, or limited future earning potential. The other may have substantially fewer necessary expenses and a strong likelihood of increasing income. The latter borrower may be less likely to qualify for a discharge.
What is the basic standard of living?
One of the first questions is whether you can maintain a basic standard of living while making your student loan payments.
The court may examine your income and necessary expenses, including your rent or mortgage, utilities, groceries, transportation, insurance, medical expenses, childcare, necessary personal expenses, and expenses associated with supporting children or other dependents.
The court may also consider whether your expenses are reasonable under the circumstances.
For example, if your rent is unusually high, the court may consider whether more affordable housing is reasonably available. The court could also examine whether a less expensive vehicle, lower-cost insurance, or other reasonable changes could reduce your expenses.
That does not mean you must eliminate every expense beyond the bare necessities. However, if your financial records show substantial discretionary spending or expenses that could reasonably be reduced or avoided, the court may ask why those funds cannot instead be used toward your student loan debt.
What If My Current Student Loan Payment Is $0?
This is becoming an increasingly important issue in student loan discharge cases.
Some federal repayment programs may result in a borrower having a required monthly payment of $0 based on income and other circumstances. What we know is that a $0 payment is relevant to the undue-hardship analysis. There have been cases in which courts have placed significant weight on the availability of an income-driven repayment program and the borrower’s ability to make a $0 payment. For that reason, an attorney handling a student loan discharge case must be prepared to address the issue directly.
At the same time, the existence of a $0 payment does not change the statutory requirement that the bankruptcy court determine whether the borrower satisfies the undue-hardship standard.
So, the question is not simply whether the federal government currently requires you to make a payment, if any. The bankruptcy court must determine whether repayment of the student loan debt creates an undue hardship under the Bankruptcy Code.
For example, if you have a $0 payment today, and your financial circumstances are likely to remain the same, and you have otherwise demonstrated good faith in dealing with your student loans, those facts may still support a discharge argument.
Also, there is an important distinction between student loan forgiveness through a repayment program and bankruptcy discharge. Forgiveness may have tax consequences that a bankruptcy discharge does not. This distinction is relevant when you are seeking discharge.
What Will the Court Consider About Your Future?
Showing that you are struggling today is only part of the analysis.
The court will also consider whether your financial circumstances are likely to improve. That can involve your age, employment history, education, job skills, current earning capacity, ability to work additional hours, ability to obtain different employment, health, family responsibilities, caregiving responsibilities, available assets, and other circumstances that could affect your future financial situation.
For someone with a serious medical condition, medical records may help demonstrate why increasing income is not realistically possible.
On the other hand, temporary unemployment does not necessarily establish a long-term hardship. The court may consider your employment history, education, skills, and realistic employment opportunities.
The court is essentially trying to understand what your financial circumstances are likely to look like in the future, not just what they look like when you file your bankruptcy case.
How Long Must the Hardship Continue?
This can be one of the more difficult issues in a student loan discharge case.
The Brunner test requires the court to consider whether the circumstances creating the borrower’s hardship are likely to persist for “a significant portion of the loan repayment period.” However, this issue has been overlooked or given limited attention in much of the case law.
Read literally, if a loan has matured and the entire balance is presently due, there is an argument that the court should focus on the borrower’s ability to repay the amount currently owed rather than speculate about the borrower’s financial circumstances many years into the future. Similarly, when a loan has been accelerated following a default and the entire balance has become due, the borrower should argue that the court should evaluate whether the borrower can realistically repay the full amount presently owed, rather than assume that the borrower will have decades to repay the debt.
This issue, again, did not receive as much attention in the case law. Instead, courts often focus on factors such as the debtor’s age, remaining working years, income, assets, health, and future earning potential, sometimes projecting those circumstances over the next 10, 20, or even 30 years.
That makes the duration of the loan an important issue to examine carefully. If the entire balance is already due, a debtor may have a strong argument that the relevant repayment period should not simply be extended into an indefinite future for purposes of the undue-hardship analysis.
A careful student loan discharge attorney should therefore examine not only the borrower’s age, income, and future earning potential, but also the actual terms of the loan, whether the loan has matured or been accelerated, and the amount presently due. These issues can materially affect how the second prong of the Brunner test should be analyzed.
Does It Matter Whether You Tried to Repay Your Student Loans?
Yes. The court may examine the steps you took to address your student loan debt before seeking a discharge.
This can include whether you made payments when you had the ability to do so, communicated with your loan servicer, reviewed available repayment options, applied for deferment or forbearance when appropriate, considered income-driven repayment programs, tried to improve your income, and reduced unnecessary expenses.
The age of the student loan may also be relevant. For example, if you borrowed the money very recently and seek bankruptcy shortly afterward without making meaningful efforts to address the debt, that timing could be viewed unfavorably.
On the other hand, a long history of struggling with the loans, making payments when possible, attempting repayment programs, and dealing with persistent financial problems show good faith.
Also, not making payments does not automatically mean that you acted in bad faith. The court will consider why payments were not made and the borrower’s overall circumstances.
Can I Seek a Discharge If I Own a Home or Have Retirement Savings?
Having assets does not automatically prevent you from seeking a student loan discharge. However, your assets can be part of the court’s overall financial analysis.
The court may consider whether you have financial resources that could reasonably contribute to your ability to repay the debt.
Retirement accounts and homes can create additional issues because certain assets may be protected under bankruptcy. But an asset being exempt does not necessarily mean that the court must completely disregard it when evaluating undue hardship.
This does not mean that every borrower with student loans must sell a home or liquidate retirement savings. However, if you have significant assets, your attorney should be prepared to explain how those assets affect, and where appropriate, do not affect, your ability to repay the student loan debt.
Can Chapter 13 Bankruptcy Help If My Student Loans Are Not Discharged?
Yes. Chapter 13 can provide relief. Depending on your circumstances, Chapter 13 may allow you to reorganize other debts, stop certain collection activity including student loan for 3-5 years, and make payments through a confirmed plan.
However, completing a Chapter 13 plan does not automatically discharge your student loans. Also, Chapter 13 cases can last three to five years, and a debtor’s circumstances can change significantly during that period. Income, expenses, employment, health, family responsibilities, and other financial factors may change.
Because those circumstances can be important to an undue-hardship determination, the timing of a student loan adversary proceeding can matter.
There is no universal rule establishing one particular time when every Chapter 13 debtor should file a student loan adversary proceeding if they wish to discharge the loan. However, if the proceeding is filed too early, the court may dismiss the proceeding as premature.
Is Chapter 7 Different?
Chapter 7 generally moves much faster than Chapter 13. You still need to file an adversary proceeding and establish undue hardship to discharge student loans.
However, one potential advantage is timing. Because a Chapter 7 case is generally completed much sooner than a Chapter 13 case, a borrower may be able to ask the bankruptcy court to address student loan discharge immediately or within a month or so after filing.
What Documents Will You Likely Need?
A student loan discharge case is generally evidence-driven.
Your attorney will need to show the court not only what your financial situation looks like today, but also why your circumstances are likely to continue.
Depending on your circumstances, you may need several years of financial records, including tax returns, bank statements, employment records, and other documentation showing your financial history.
You will also likely need current pay statements, a detailed household budget, student loan account statements, payment history, communications with your loan servicer, and information concerning repayment programs.
If health problems affect your ability to work or earn income, medical records and disability documentation may also be important. Evidence concerning your employment history, job searches, family responsibilities, or caregiving obligations may also help establish the circumstances affecting your ability to repay.
The exact documents needed will depend on the facts of your case.
What Should You Do If Your Student Loans Have Become Unmanageable?
If you are struggling with student loans, do not assume that bankruptcy is automatically off the table.
Instead, have your entire financial situation evaluated.
The important questions are not simply how much you owe or what your required payment is today. Your attorney should also examine your income, necessary expenses, employment prospects, health, family circumstances, assets, repayment history, and the likelihood that your financial hardship will continue.
A student loan discharge case requires more than simply telling the court that you cannot afford your loans. You need to present evidence showing why repayment would create an undue hardship to you or your depends.
Talk to ClearPath Law About Your Student Loan Debt
Student loan bankruptcy cases are highly dependent on the individual facts. There is no single income level, debt amount, or monthly payment that automatically determines whether you qualify for a discharge.
If your student loans have become overwhelming and you are considering bankruptcy, ClearPath Law can review your financial circumstances and explain your options.
