Students with tens of thousands of debt upon graduation and no job (or a poorly paying job) often ask, “Can I discharge my student loans in bankruptcy?” or “Will bankruptcy remove your student loans?” Concrete answers are elusive, but the general answer is “no.” Under certain circumstances, however, student loans can be discharged in bankruptcy if the debtor suffers from an “undue hardship.”
Schools and student lenders have lobbied Congress to ensure that no matter how overwhelming a graduate’s debt becomes, she will not be able to declare bankruptcy to get rid of them. Credit card debt, gambling debt, car loans, home loans, personal loans, civil court judgments, and business debts–just to name a few–are all regularly dischargeable in bankruptcy. Student loans are not.
When a loan or other debt is discharged in bankruptcy, it is forever wiped away. The lender can no longer collect the loan from the debtor, and the debtor no longer faces the prospect of a judgment, garnishment, or other action to recover the loan. Of course, bankruptcies show up on credit reports, and those who have filed bankruptcy in the past face tighter restrictions on credit in the future. So the the view that bankruptcy is a cure-all is simply not true. But bankruptcy can, in the right circumstances, provide an answer for those who are in over their heads.
This post largely summarizes a recent article, “Student Loans in Bankruptcy: The Undue Hardship Test is an Unnecessary Burden” [pdf] by James M. Leiby of the University of Michigan Law School. The article was written for a law journal, so it contains a lot of legalese. What follows is a summary of the article in terms that are easier to read.
Student loans used to be dischargeable in bankruptcy. When the National Direct Student Loan (NDSL) program was enacted as part of the National Defense Education Act (NDEA) of 1958, student loans were fully dischargeable. The NDSL was the first federally funded student loan program, and it launched what is now known as the Perkins Loan program. A few years later, Congress enacted the Guaranteed Student Loan (GSL) program as part of the Higher Education Act of 1965. The GSL is the predecessor to the Federal Family Education Loan (FFEL) program, which has been replaced by the William D. Ford Direct Loan program.
The NDSL and GSL programs spurred an enormous increase in student lending. This increase eventually caused a backlash against student borrowers, as some graduates abused the bankruptcy courts by filing for bankruptcy immediately upon graduation. In response to this problem, the Commission on Bankruptcy Laws issued a report in 1973 recommending that student loans be exempted from discharge in bankruptcy.
In 1976, Congress amended the Higher Education Act, which specifically exempted student loans from discharge. This new law came with two caveats: First, the only loans protected from discharge were federally insured or guaranteed loans. Private student loans were not exempt from discharge. Second, student loans were only exempted from discharge for five years after entering repayment. A student seeking discharge within the first five years would need to show an “undue hardship.” After five years, student loans were dischargeable like any other debt.
Congress continued to expand the dischargeability exemption. In 1979, Congress expanded the exemption to “any program funded in whole or in part by a governmental unit or a nonprofit institution of higher education.” In 1984, Congress removed “of higher education” from the language of the Bankruptcy Code. Additional modifications to the Bankruptcy Code exempted student loans from discharge under Chapter 13 bankruptcies, in addition to Chapter 7. (Under Chapter 13, a debtor can pay off a smaller amount of debt over a period of time; under Chapter 7, debts are wiped away.) In 1992, Congress extended the nondischargeability period to seven years.
Major changes came in 1998 and again in 2005. In 1998, Congress removed the seven-year limit to dischargeability. In 2005, Congress extended nondischargeability to private student loans. In this way, all student loans are now protected from dischargeability under the Bankruptcy Code.
Under the Bankruptcy Code, student loans may only be discharged if the debtor would suffer “undue hardship.” The Bankruptcy Code does not define “undue hardship,” so courts have developed tests for such.
The majority rule, which is used in the Second, Third, Fourth, Fifth, Sixth, Seventh, Ninth, Tenth, and Eleventh Circuit (what circuit am I in?) have adopted the Brunner Test, named after the case in which it was first used, Brunner v. New York Higher Education Services Corp. Under this test, in order to discharge a student loan, the debtor must show (1) that based on her current income, she will not be able to preserve a “minimal” standard of living for herself and her dependents if she is forced to repay the loan; (2) that other evidence indicates that the debtor’s inability to maintain a minimal standard of living is likely to continue for a significant part of the repayment period; and (3) that the debtor has made good faith attempts to repay the loans.
Three examples of cases decided under the Brunner Test are Brunner v. New York Higher Education Services Corp., Hemar Insurance Corp. v. Cox, and United Student Aid Funds, Inc. v. Pena.
The Eighth Circuit and some courts in the First Circuit use a “totality of the circumstances” test. In this case, the court looks to all the surrounding circumstances of the case, including a debtor’s past, present, and likely future income, reasonable living expenses, and any other relevant facts unique to the debtor’s situation.
Unfortunately, as Leiby demonstrates by his analysis of these cases, a debtor bears a heavy burden to prove “undue hardship.” The standard might as well be “extreme hardship” or “impossible to ever pay back.”
Leiby concludes that the nondischargeability of student loans is unjustified. First, Leiby contends that abuse of the bankruptcy system is a myth. Second, Leiby argues that allowing student loans to be discharged would not discourage lenders from making student loans. Third, and most importantly in my opinion, Leiby argues that the purposes of the Bankruptcy Code–“to grant a fresh start to the honest by unfortunate debtor”–would be better served by allowing student loans to be discharged. Moreover, the current Bankruptcy Code prefers student loans to credit card debt and health and medical debt. Allowing student loans to be discharged with credit card debt and health and medical debt would put these lenders on an even plane.
Leiby advocates repealing the provisions of the Bankruptcy Code that prevent discharge of private student loans. This would be a good first step, but Leiby does not stop there. He advocates that all non-governmental loans should be dischargeable. But the best option, he concludes, is that all student loans should be dischargeable, without the debtor having to pass the “undue hardship” test. Leiby also offers that the five- or seven-year limit non nondischargeability might be the most practical resolution.
Are you seeking to discharge your student loans? Talk about it on the Student Loan Discussion message boards.
(Note: None of the information contained in this post is intended to be legal advice. As always, talk to an attorney for any legal issues that you might have.)
- Pwn (v.) Slang term derived from the verb own, as meaning to appropriate or to conquer to gain ownership. The term implies domination or humiliation of a rival.