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It is almost impossible to discharge student loans in bankruptcy. Only about 1 in 2,500 student loan borrowers who file for bankruptcy succeed in obtaining a full or partial discharge of their student loans. Nevertheless, there are several ways that borrowers can qualify for a bankruptcy discharge. Here’s how.
History of the Bankruptcy Discharge for Student Loans
Prior to 1976, federal and private student loans could be discharged in bankruptcy.
Starting in 1978, borrowers had to wait five years before their student loans could be discharged, unless they could demonstrate that repaying the loans imposed an “undue hardship” on the borrower and the borrower’s dependents.
This waiting period was increased to seven years in 1990. The option to discharge student loans after a number of years in repayment was eliminated in 1998. At that point, demonstrating undue hardship in an adversarial proceeding was the only option for bankruptcy discharge.
The exception to discharge was expanded to cover private student loans in 1984, if the loans were made through a program that is funded in whole or in part by a non-profit institution. This led to the creation of The Education Resources Institute (TERI), a non-profit student loan guarantor, in 1985. (TERI filed for bankruptcy itself in 2008, an option not available to the borrowers whose loans it guaranteed.)
The requirement for the involvement of a non-profit organization in the private student loan program was eliminated in 2005, when Congress expanded the exception to discharge to prevent discharge of qualified education loans. Qualified education loans include all federal and most private student loans.
President-elect Joe Biden has called for restoring bankruptcy rights for student loans.
Definition of Undue Hardship
Congress never defined what it meant by “undue hardship.” It was left to the courts to define the term. The courts settled on two definitions, the Totality of Circumstances Test (1981) and the Brunner Test (1987).
The Totality of Circumstances Test provides a method for demonstrating undue hardship based on the borrower’s current and future financial resources and the necessary living expenses of the borrower and the borrower’s dependents, as well as any other relevant facts and circumstances. It is the more flexible of the two tests.
The Brunner Test is a three-pronged test for demonstrating undue hardship. The first two prongs are similar to the totality of circumstances test. The third prong is new.
- The first prong requires the borrower to demonstrate that they are currently unable to maintain a minimal standard of living for the borrower and the borrower’s dependents while repaying the student loans.
- The second prong requires this situation to be likely to persist for most of the repayment term of the loans.
- The third program requires the borrower to have made a good faith effort to repay the debt, such as using deferments, forbearances and income-driven repayment plans to reduce the monthly loan payment.
The Totality of Circumstances Test has been adopted by the 8th circuit. The Brunner Test has been adopted by the 2nd, 3rd, 4th, 5th, 6th, 7th, 9th, 10th and 11th circuits.
Demand Proof that You Owe the Debt
Always demand documentation of the student loans, such as a copy of a signed promissory note. If the lender cannot provide this documentation, they can’t prove that you owe the student loans or that they own the debt. In some cases, the courts will allow them to proceed if they can prove that you received or benefited from the proceeds of the loans.
Even if the lender produces a signed promissory note, you can challenge its legitimacy by providing copies of your signature on contemporaneous documents from the same time as the promissory note. If the two signatures differ, it may demonstrate that you are a victim of identity theft.
You can also challenge the legitimacy of the promissory note if you were in federal or state prison at the time the loans were made, since incarcerated individuals are ineligible for federal student loans.
Demonstrating Undue Hardship May Not Be Necessary
If you can show that the student loans are not qualified education loans, demonstrating undue hardship might not be necessary for the loan to be discharged in bankruptcy.
There are many situations in which a student loan is not a qualified education loan. These are some of the more common examples. Note that these loans are not considered qualified education loans because of the design of the loan program, not necessarily because of the way in which the borrower chose to use the loan proceeds.
- Bar Study Loans and Residency and Relocation Loans are not qualified education loans because they are borrowed for expenses incurred after the student graduated and because the expenses are not qualified higher education expenses.
- Continuing Education Loans and Career Training Loans are not qualified education loans because they are made to students who are not enrolled on at least a half-time basis. Also, for a student loan to be a qualified education loan, the student must be pursuing a degree or certificate or other recognized education credential at a college or university that is eligible for Title IV federal student aid. Continuing education students are not pursuing a degree or certificate.
- K-12 Loans are not qualified education loans because the student cannot be enrolled in an elementary or secondary school. For similar reasons, loans made to dual enrollment students are not qualified education loans, since a dual enrollment student is enrolled simultaneously in a college and an elementary or secondary school.
- Direct-to-Consumer Loans may be dischargeable because they are designed to permit borrowing beyond the college’s cost of attendance, as they are not school certified.
- Mixed-Use Loans are not qualified education loans because they are not borrowed solely to pay for qualified higher education expenses. Examples of mixed-use loans include credit cards, auto loans, personal loans, home equity loans, home equity lines of credit and other types of mortgages (e.g., a cash-out refinance).
- Retirement Plan Loans are not qualified education loans because such loans are excluded from the definition of a qualified education loan.
- Loans Made by Relatives are not qualified education loans because the debt is owed to someone who is related to the borrower. This includes loans owed to a brother or sister (whether by whole or half-blood), spouse, ancestor or lineal descendant.
- Loans for Prior-Year Balances are not qualified education loans because they are not made within a reasonable period of time (90 days) before or after the qualified expenses are paid or incurred. This requirement does not apply to a refinance of a qualified education loan.
- Loans for the Purchase of a Computer and Obtaining Professional Licenses or Certification are not qualified education loans because these expenses were added to the definition of cost of attendance after August 4, 1997. Room and board for less-than-half-time students was also added after this date, but those loans would also be non-qualified because the students are enrolled less than half-time.
- Loans Made to the Student’s Grandparent, Aunt, Uncle, Niece, Nephew, Sibling, Cousin or Stranger are not qualified education loans, since the student must be the borrower, the borrower’s spouse or a dependent of the borrower.
- Loans for Unaccredited Colleges or Universities are not qualified education loans because the loan must have been used to pay for qualified expenses at an eligible institution, which is defined as a college or university that is eligible for Title IV federal student aid.
- Loans for Foreign Colleges and Universities might not be qualified education loans, depending on the specific college or university, for similar reasons. Only about 400 foreign colleges and universities are eligible for Title IV federal student aid.
A refinance of a qualified education loan is considered a qualified education loan. So, if a borrower uses a cash advance from a credit card to refinance a qualified education loan, the credit card debt may nevertheless be non-dischargeable because the prohibition on mixed-use debt applies to the original qualified education loan and not a refinance of that loan. There might be some wiggle room, but it has not been tested in the courts and it might run afoul of the anti-abuse provisions in the U.S. Bankruptcy Code.
How to Demonstrate Undue Hardship
It is more difficult to demonstrate undue hardship on federal loans that private student loans because federal student loans offer income-driven repayment plans while most private student loans do not. The federal government often argues that the availability of income-driven repayment plans and the total and permanent disability discharge prevents borrowers from experiencing undue hardship. This is not always true.
Some of the circumstances in which a borrower could demonstrate undue hardship even with an income-driven repayment plan include:
- The borrower’s necessary expenses, such as medical and disability-related expenses, may be high enough that they are unable to maintain a minimal standard of living while repaying the student loans, even in an income-driven repayment plan.
- The borrower is divorced or separated and their alimony and child support obligations, when combined with the student loan payments, do not allow the borrower to maintain a minimal standard of living while repaying the student loans.
- The borrower lives and works in a city with a high cost of living, such as Alexandria (VA), Boston (MA), Brooklyn (NY), Honolulu (HI), Los Angeles (CA), Manhattan (NY), San Diego (CA), San Francisco (CA), Seattle (WA) and Washington (DC).
Some of the circumstances in which a borrower might be able to demonstrate undue hardship because of a disability include:
- The borrower is totally and permanently disabled, but has private student loans that do not offer a disability discharge.
- The borrower’s dependent is disabled, as opposed to the borrower. Federal student loans and some private student loans can be discharged if the borrower has a total and permanent disability, but not if the borrower’s dependent has a severe disability. The dependent’s disability may involve high ongoing dependent care costs, such as 24/7 nursing, that make the student loan payments unaffordable even with an income-driven repayment plan. The borrower may also be unable to maximize their income because they need to take care of the disabled dependent.
- The borrower’s disability is severe, but does not qualify for a total and permanent disability discharge.
- The borrower depends on Social Security disability as their sole source of income, but their next disability review is less than five years after their most recent disability status determination or review.
- The borrower qualifies for a total and permanent disability discharge, but their earned income during the post-discharge monitoring period exceeds the poverty line for a family of two, causing the loans to be reinstated. This may be particularly problematic for borrowers who have more than one dependent.
- The borrower lives outside the U.S. and cannot find a local doctor who can certify the total and permanent disability discharge application. U.S. Department of Education rules require the doctor to be licensed to practice medicine in the U.S.
Other scenarios in which a borrow may be able to demonstrate undue hardship include:
- If the borrower’s private student loans do not offer an income-driven repayment plan, the borrower’s debt-to-income ratio may be high enough that the borrower cannot maintain a minimal standard of living even with the lowest monthly loan payment option provided by the lender. The borrower may be unable to repay their debts even if they maximize income and minimize expenses. The borrower’s student loan debt may be so excessive that the borrower will never be able to repay the student loans.
- The borrower has very low income. Although this may qualify them for an income-driven repayment plan if their income is less than 150% of the poverty line, it also satisfies the requirements for the first prong of the Brunner Test.
- The borrower is unable to earn enough income to repay the student loans and there are no prospects for increasing their income. This can occur when the borrower’s job opportunities are limited by age, disability or illness. It can also occur when the borrower dropped out of college or the borrower’s degree does not qualify them for gainful employment. It can also occur when a borrower or cosigner is on fixed income.
- The borrower has federal student loans that are ineligible for an income-driven repayment plan. For example, Federal Parent PLUS loans are not directly eligible for income-driven repayment plans. There is a narrow loophole that allows Parent PLUS Loans to qualify for income-contingent repayment if the loans entered repayment on or after July 1, 2006 and the loans are included in a Federal Direct Consolidation Loan. The monthly loan payment under income-contingent repayment is more than double the loan payment under pay-as-you-earn repayment.
- The borrower has reached the 3-year limits on federal student loan deferments and forbearances or the 1-year limits on private student loan forbearances and there are no other affordable options available to the borrower.
If a borrower’s discharge petition is disallowed under the Brunner Test but might have been allowed under the Totality of Circumstances Test, they be able to argue that their student loans should be discharged under equal protection grounds. Article I, Section 8, Clause 4 of the U.S. Constitution provides Congress with the power to establish “uniform laws on the subject of bankruptcies throughout the United States.” To date, no borrower has pursued such a case because borrowers who file for bankruptcy do not have the financial resources needed to take their case to the U.S. Supreme Court.