Bankruptcy is a legal process where individuals or businesses seek protection from their creditors and a fresh start for their financial lives. Bankruptcy can provide relief to those who are struggling to pay their debts by discharging certain types of debts, restructuring others, or simply putting a pause on collections efforts. However, bankruptcy does not always mean that all debts will be forgiven. When it comes to student loan debt, declaring bankruptcy does not guarantee a discharge of the debt. In this BrokeScholar article, we’re going to break down the effects of bankruptcy on student loan debt and the options available to those who are struggling to pay their student loans.
Student loan debt in the United States is a growing problem. According to the Federal Reserve, as of the second quarter of 2022, Americans collectively owe over $1.7 trillion in student loan debt. This debt can be overwhelming, especially for those who are struggling to make their monthly payments. For many borrowers, bankruptcy seems like a viable option to get out from under the burden of student loan debt. However, the reality is that it is very difficult to discharge student loans in bankruptcy.
Why Doesn’t Bankruptcy Get Rid of Student Loan Debt
The reason why bankruptcy does not typically eliminate student loan debt is due to the provisions set forth in the U.S. Bankruptcy Code. Specifically, in 1976, Congress enacted legislation that restricted the discharge of certain debts, including student loans, in bankruptcy.
The Bankruptcy Code was later amended in 1990 to make it even more difficult to discharge student loans in bankruptcy. Under current law, student loans can only be discharged in bankruptcy if the borrower can demonstrate "undue hardship."
The concept of "undue hardship" is not defined in the Bankruptcy Code, so the courts have developed a three-part test to determine whether a borrower meets this standard. The test, known as the Brunner test, requires the borrower to show:
- That they cannot maintain a minimal standard of living for themselves and their dependents if they are forced to repay their student loans;
- That their current financial situation is likely to persist for a significant portion of the repayment period; and
- That they have made a good faith effort to repay their student loans.
The Brunner test sets a high standard for borrowers to meet, and as a result, very few borrowers are able to discharge their student loans in bankruptcy. Courts have interpreted the test in different ways, with some requiring evidence of extraordinary circumstances such as permanent disability, while others have been more lenient in their interpretation.
One of the reasons why Congress limited the discharge of student loans in bankruptcy was to prevent borrowers from using bankruptcy as a way to escape their financial obligations. Student loans are often taken out to finance education, which is considered an investment in the borrower's future. By limiting the discharge of student loans in bankruptcy, Congress sought to ensure that borrowers take their student loan obligations seriously and make a good faith effort to repay them.
Another reason why student loans are not typically dischargeable in bankruptcy is because they are often guaranteed or issued by the federal government. Unlike other types of debt, such as credit card debt or medical debt, student loans are backed by the full faith and credit of the U.S. government. This means that if borrowers were allowed to discharge their student loans in bankruptcy, it could potentially have a significant impact on the federal government's ability to provide student loans in the future.
Thus, the limited discharge of student loans in bankruptcy is a result of legislation passed by Congress and the interpretation of the courts. While some borrowers may be able to demonstrate “undue hardship” and have their student loans discharged, the process is difficult and the standard is high. As a result, borrowers should explore other options, such as income-driven repayment plans or loan forgiveness programs, before considering bankruptcy as a way to manage their student loan debt.
How To Get Rid of Student Loan Through Bankruptcy
In order to discharge student loans in bankruptcy, borrowers must prove that paying back the loans would cause them “undue hardship”. This is a very high standard to meet and requires borrowers to prove that they cannot maintain a minimal standard of living if they are forced to repay their student loans. In addition, the borrower must show that their financial situation is unlikely to improve in the future. This is known as the Brunner test, named after a court case that established the standard for discharging student loans in bankruptcy.
Proving “undue hardship” can be a difficult and lengthy process. It requires the borrower to file an adversary proceeding in bankruptcy court, which is essentially a lawsuit within the bankruptcy case. The borrower must present evidence to the court showing that they cannot pay their student loans and that their financial situation is unlikely to improve. This can involve submitting financial documents, such as tax returns and bank statements, as well as providing testimony from experts, such as economists and vocational rehabilitation specialists.
Even if a borrower is successful in proving “undue hardship”, the discharge of student loans is not guaranteed. The decision to discharge student loans is ultimately up to the bankruptcy judge, who may or may not agree with the borrower's argument. In addition, the discharge of student loans is not automatic and may require additional steps, such as submitting a separate motion to the court.
Other Options to Address Student Loan Debt Troubles
Given the difficulty of discharging student loans in bankruptcy, many borrowers may be better off exploring other options to manage their student loan debt. For example, borrowers may be eligible for income-driven repayment plans, which cap monthly payments based on the borrower's income and family size. These plans may also offer forgiveness after a certain number of payments have been made, typically 20-25 years.
Another option is to negotiate a repayment plan with the lender. This can involve extending the term of the loan or lowering the interest rate to make payments more manageable. Borrowers should be aware that these options may result in paying more interest over the life of the loan, but they may be preferable to defaulting on the loan or declaring bankruptcy.
Finally, borrowers may also consider seeking the assistance of a credit counselor or debt relief agency. These organizations can work with borrowers to develop a budget and repayment plan, negotiate with lenders on their behalf, and provide financial education and counseling.
Bear in mind that declaring bankruptcy can have other consequences besides the discharge of student loans. Bankruptcy can negatively impact a borrower's credit score, making it difficult to obtain credit in the future. What’s more, bankruptcy can affect the borrower's ability to rent an apartment, get a job, or obtain insurance. These consequences should be carefully considered before deciding to declare bankruptcy.
In the end, declaring bankruptcy is not a simple solution to student loan debt. Discharging student loans in bankruptcy is very difficult and requires borrowers to meet a high standard of proving “undue hardship”. Even if successful, the discharge of student loans is not guaranteed and may require additional steps. Borrowers should explore other options, such as income-driven repayment plans or negotiation with lenders, before considering bankruptcy. It is also important to consider the potential consequences of bankruptcy on credit scores, future opportunities, and overall financial well-being.
Furthermore, it is worth noting that there have been recent developments in the legal and political landscape surrounding bankruptcy and student loans. In March 2021, the Biden administration announced that it would be conducting a review of the Department of Education's legal authority to cancel student loan debt through executive action. While this review is ongoing, it is important for borrowers to continue to explore all available options and to stay informed of any changes to bankruptcy and student loan policies.
On top of that, there have been recent court cases that challenge the current standard for discharging student loans in bankruptcy. For example, in January 2022, a bankruptcy judge in New York ruled that a borrower could discharge $220,000 in student loan debt because the borrower's financial situation was unlikely to improve in the future. This ruling deviated from the Brunner test and could potentially open the door for more borrowers to discharge their student loans in bankruptcy.
While it is unclear how these legal and political developments will ultimately impact the ability to discharge student loans in bankruptcy, it is important for borrowers to stay informed and seek legal advice if considering bankruptcy as an option for managing their student loan debt.
The Bottom Line on Student Loan Debt and Bankruptcy
Student loan debt can be a significant burden for borrowers and bankruptcy may seem like an attractive option to discharge this debt. However, the reality is that discharging student loans in bankruptcy is very difficult and requires borrowers to meet a high standard of proving undue hardship. It is essential for borrowers to explore all available options, such as income-driven repayment plans and negotiation with lenders, before considering bankruptcy. It is also central to understand the potential consequences of bankruptcy on credit scores, future opportunities, and overall financial well-being. Finally, borrowers should stay informed of any changes to bankruptcy and student loan policies and seek legal advice if considering bankruptcy as an option.
