Can Student Loans Be Discharged in Bankruptcy?

Filing for bankruptcy can be a difficult decision for many people. It impacts your credit score and ability to take out loans for years. But sometimes, it is the only option when you are drowning in debt and unable to keep up with payments. One of the big questions that comes up is whether filing for bankruptcy can discharge your student loans.

The answer, unfortunately, is complicated. Unlike other types of consumer debt like credit cards or medical bills, student loans are not automatically discharged when you file for bankruptcy. You typically have to take extra steps to try to prove to the court that repaying your student loans would cause you “undue hardship.”

This is thanks to a change in federal law back in the 1970s that made federal student loans nearly impossible to discharge in bankruptcy except in extreme circumstances. The goal was to prevent abuse of the system by people filing for bankruptcy right after graduating. But over time, the rules have made it very difficult for any borrower to get student loan debt discharged.

The Undue Hardship Standard

To have your student loans discharged in bankruptcy, you need to file an “adversary proceeding” and prove to the bankruptcy court that repaying your student loan debt would cause “undue hardship.” This is a very tough legal standard to meet.

There is no single legal test to determine if a borrower meets the criteria for undue hardship. But many courts use something called the Brunner test, which requires you to prove:

• You cannot maintain a minimal standard of living if forced to repay your student loans
• Your financial situation is likely to persist for a significant portion of the repayment period
• You have made good faith efforts to repay the loans

As you can see, the bar is very high. You need to essentially prove that you are totally incapable of repaying the loans now and in the foreseeable future, through no fault of your own. Things like having a low income, high debt, or medical issues are often not enough on their own.

The Adversary Proceeding

An adversary proceeding is essentially a separate lawsuit within the bankruptcy case where you argue why your loans should be discharged for undue hardship. You need to file a complaint with the bankruptcy court detailing your circumstances and request a discharge of your student loans.

The student loan lender can fight your request by arguing that you do not meet the undue hardship criteria. They will likely comb through your finances and point out any areas where you may be able to cut expenses or earn more income to pay the loans.

Adversary proceedings can be expensive, lengthy, and invasive. You may need to provide lots of documentation about your finances, employment history, health, education records, and more. Expect the process to take several months at least, with no guarantee of success.

The Costs

Filing an adversary proceeding requires hiring a bankruptcy lawyer, which can cost between $2,000-$5,000 or more. If your loans are very high, it may be worth the legal costs to pursue discharge. But for smaller debts, the lawyer fees could outweigh the benefit.

In addition to lawyer fees, you still need to pay the court filing fees for the bankruptcy case and adversary proceeding, which can total $500 or more. And if you lose, you may be ordered to pay the lender’s legal fees too.

Success Rates

Only a tiny fraction of student loan borrowers who file for bankruptcy succeed in getting their loans discharged. By some estimates, less than 1% of cases lead to discharge. The rest are either settled, dismissed, or the borrower gives up.

Your chances depend heavily on which court oversees the case. Some bankruptcy judges are more sympathetic than others. Outcomes can also vary by circuit court precedents. For example, the 2nd Circuit (NY, VT, CT) has a reputation for having some of the most debtor-friendly undue hardship rulings.

Alternatives to Discharge

Given the low odds of success, you may want to consider alternatives to discharge that provide some relief without as much cost:

• Deferment or forbearance – Temporarily postpone payments
• Income-driven repayment – Lower monthly payments based on income
• Loan rehabilitation – Get out of default by making 9 payments
• Loan consolidation – Combine loans into one payment

If you file for bankruptcy, any federal student loans in default will be “rehabilitated” as part of the process. This removes the default status after you make nine on-time payments during or after bankruptcy.

Private Student Loans

Loans from private lenders like banks and credit unions are treated differently than federal loans in bankruptcy. They are dischargeable like other consumer debt, without needing to prove undue hardship. So if you have both federal and private student loans, make sure to specify in your bankruptcy petition that you want the private loans discharged.

However, if you took out private student loans more than 90 days before filing for bankruptcy, the loans may still be considered “nondischargeable.” Talk to your lawyer about the timing.

The Future

In recent years, there has been growing recognition that the undue hardship standard for student loan discharge is too rigid. In 2013, the American Bankruptcy Institute issued recommendations calling for a more flexible “totality of circumstances” test.

Some courts have begun applying a more holistic approach, looking at factors like a borrower’s good faith efforts to repay and the impact of medical issues. There have also been calls for Congress to reform the bankruptcy laws to make discharge easier in certain situations.

In the meantime, options like income-driven repayment plans help provide relief for borrowers struggling with high monthly payments. But for those facing truly hopeless circumstances, filing an adversary proceeding, while difficult, may offer the light at the end of the tunnel.