Discharge of Student Loans in Bankruptcy
Student loans, the largest source of debt for many Americans, are treated differently than other debts in bankruptcy. You may have heard that it is nearly impossible to discharge student loans in bankruptcy. However, that is not true, especially in light of recent developments. If you are contemplating bankruptcy, and you have student loan debt, it is imperative that you understand how your student loans will be affected by the filing of a bankruptcy proceeding.
At The Law Office of Andrew M. Doktofsky, P.C., I understand how student loan debt is impacted by bankruptcy, and can guide you through the bankruptcy process so you can decide what is best for you.
Discharge of Student Loans – Undue Hardship Requirement
In general, student loans may be discharged in bankruptcy only if the bankruptcy court finds that repayment of the loan would impose an “undue hardship” on the debtor and the debtor’s dependents. Undue hardship is not defined in the Bankruptcy Code, and it is left to the courts to make a determination in each case. Different tests have been developed by the courts, and the applicable test will usually depend on the federal appellate court circuit in which the debtor’s bankruptcy case is filed.
In the Second Circuit, which includes New York State, the applicable standard is known as the “Brunner Test,” which was established in Brunner v. New York State Higher Education ServicesCorp., 831 F.2d 395, 396 (2d Cir. 1987). Under the Brunner Test, a student loan may be deemed an undue hardship only if all of the following conditions are met:
- The debtor cannot maintain a minimal standard of living for himself and his dependents if forced to repay the loan; and
- Additional circumstances exist that indicate this condition is likely to persist for a significant portion of the repayment period of the student loan; and
- The debtor has made good faith efforts to repay the loan
Courts have applied the Brunner Test very stringently, and it has generally been very difficult for debtors to successfully discharge student loans in bankruptcy.
Recent Department of Justice Guidelines Make it Easier to Discharge Student Loans in Bankruptcy
In December 2022, the Department of Justice, in coordination with the U.S. Department of Education, issued a memorandum revising how the DOJ and Education Dept. respond to requests by debtors in bankruptcy to discharge federal student loans. The goals of the new guidelines are:
- To set clear, transparent, and consistent expectations for discharge;
- To reduce debtors’ burdens in pursuing an adversary proceeding by simplifying the fact- gathering process. This includes use of an Attestation, and where feasible, information provided through prior submissions to the bankruptcy court and available student loan servicing records;
- Where the facts support it, to increase the number of cases where the government stipulates to the facts demonstrating a debt would impose an undue hardship and recommends to the court that a debtor’s student loans be discharged.
Debtors should have an easier path to discharge of their student loan debt under the new guidelines. If you have student loan debt that you are unable to repay, a Chapter 7 or Chapter 13 bankruptcy should now be considered. Keep in mind, however, that the DOJ guidelines are not law, and the discharge of student loans must be approved by a bankruptcy judge.
Discharge of Private Student Loans
Certain private student loans are dischargeable in bankruptcy, without the need to demonstrate undue hardship. Under Bankruptcy Code § 523(a)(8)(B), private student loans are non-dischargeable in bankruptcy only if the loan is a “qualified education loan”. A “qualified education loan” is any indebtedness incurred by the taxpayer solely to pay “qualified higher education expenses”. The term “qualified higher education expenses” means the cost of attendance at “an eligible educational institution”.
An “eligible educational institution” means an institution that is eligible to participate in a program under Title IV of the Higher Education Act of 1965. To determine if a school is eligible under Title IV, search the Federal School Code List for the year(s) that you attended the school. If the school is not listed, then it was not an eligible educational institution. Many vocational schools and foreign schools are, or were not, Title IV schools, and private student loans issued to attend these schools are dischargeable in bankruptcy.
In addition to the school’s Title IV eligibility, other factors may allow for the discharge of private student loans. These include:
– The loan must have been used exclusively for educational expenses. If the loan exceeds the average cost of attendance at the school that the debtor attended, then the entire loan may be discharged. Cost of attendance includes tuition, fees, books, room and board, and other necessary expenses.
– The student must have been enrolled in at least half of a full-time program.
– The course of study must lead to a degree.
– The student cannot be an undocumented alien.
– The student cannot be incarcerated at the time of attendance.
– The borrower (if not the student) must be the student’s spouse, or someone who claims the student as a dependent.
To discharge student loans in bankruptcy, it is necessary to file a separate adversary proceeding within the bankruptcy case, to obtain a court determination as to the dischargeability of the loans.
Unless discharged, student loans are generally unaffected by a Chapter 7 bankruptcy case, except to the extent that collection activities must cease during the time that the automatic stay is in effect. For a simple Chapter 7 case, the stay remains in effect from the filing of the bankruptcy until the discharge is issued, which is approximately three months later.
Student Loans In Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, student loans may cause unanticipated problems. This is because, in most cases, the Chapter 13 plan treats student loans in the same manner as other unsecured, non-priority debts. That is, unsecured debts are paid on a pro-rata basis, with each creditor receiving a share of the total amount paid, based on the amount that is owed to that creditor.
One problem that arises in Chapter 13 is that the pro-rata amount to be paid for the debtor’s student loans under the Chapter 13 plan may be less than what is necessary to keep the loans current. The bankruptcy filing places an automatic stay against collection activity during the time that the case is pending. So, while student loan creditors cannot try to collect payments from the debtor outside of the Chapter 13 plan, the debtor will continue to fall behind on his or her student loan payments during the three to five-year plan period. In addition, interest will continue to accrue on the student loan balance. Interest on nondischargeable student loans that accrues after the bankruptcy filing is also nondischargeable.
The result in this situation is that at the end of the Chapter 13 plan, the debtor will owe unpaid principal and interest on the student loans. Thus, the debtor may emerge from Chapter 13 owing a substantial amount on his or her student loan debt, possibly even more than was owed before the bankruptcy filing. The outcome for the debtor will depend on the pro-rata percentage that is paid to unsecured creditors in the Chapter 13 plan, as well as the student loan interest rate.
Separate Classification Of Student Loan Debt In Chapter 13
Can student loans be given preferential treatment in Chapter 13? The Bankruptcy Code contains conflicting provisions that, depending on a court’s determination, may allow such preferential treatment.
Under Bankruptcy Code § 1322(b)(5), a Chapter 13 plan may allow maintenance of payments for claims on which the last payment is due after the date on which the final payment under the plan is due. Since a Chapter 13 plan cannot exceed five years, the final payment on most student loans will be due after the Chapter 13 plan is completed. Thus, this section of the Bankruptcy Code would seem to allow a debtor to continue to make regular student loan payments directly to the lender, outside of the plan. The benefit of doing so is that the debtor would stay current on both the principal and interest for the student loan while at the same time repaying other creditors through the Chapter 13 plan.
However, under Bankruptcy Code § 1322(b)(1), a Chapter 13 plan may designate separate classes of unsecured claims, but only if the plan does not discriminate unfairly against any class. What constitutes unfair discrimination is a factual matter that must be determined by the bankruptcy court on a case-by-case basis. The court will look at several factors to determine whether the proposed classification unfairly discriminates against unsecured creditors. These factors include:
- Whether there is a rational basis for the classification
- Whether the classification is necessary for the debtor’s rehabilitation
- Whether the discriminatory classification is proposed in good faith
- Whether there is a meaningful payment to the class discriminated against
- The difference between what the creditors discriminated against will receive as the plan is proposed, and the amount they would receive if there was no separate classification
If approved by the court, classifying student loan debt separately from other unsecured debts in a Chapter 13 plan may be very advantageous to the debtor. Separate classification will allow the debtor to remain current on student loans while other, unsecured creditors are paid less through the plan. However, obtaining confirmation of such a plan will generally be difficult to do, and only when the right circumstances exist.
Finally, in Chapter 13 plans that propose to pay 100% of unsecured debts, student loans can generally be paid outside of the plan.
Discuss Your Options With A Skilled Attorney
If you have student loan debt and are thinking of filing for bankruptcy, there are many important factors that must be considered. You should consult with a knowledgeable and experienced bankruptcy attorney to provide you with the advice necessary to make an informed decision. Contact The Law Office of Andrew M. Doktofsky, P.C., at 631-812-7712 or reach out online to schedule a free consultation.
This is a debt relief agency. I help people file for bankruptcy relief under the Bankruptcy Code.