Student Loan Bankruptcy Policy

Although bankruptcy discharges most debt, some debt will remain. In Chapter 7 and Chapter 13, student loans are generally not eligible for discharge. This protects the financial institutions that grant the loans from loss. However, in some student loan bankruptcy cases, when the debt causes an undue hardship a bankruptcy judge may discharge the loan.

Previous Law

Prior to 2005, student loans from nonprofit organizations were not eligible for discharge in bankruptcy unless an undue hardship existed. However, a bankruptcy judge could discharge a student loan made by a commercial entity. Under the current law, nonprofit and commercial lenders now receive the same protection. This means that student loans are not eligible for discharge unless the debtor establishes the existence of an undue hardship. 

Reasons for Discharge 

A court will determine undue hardship by applying the three-factor test or by considering the “totality of the circumstances.” Under the three-factor test, the court will look at the following:

• Poverty: The court will look at whether the debtor’s income is enough to repay the loan and still live according to the minimum standard of living, whether the debtor will potentially earn more income in the future, whether the debtor has marketable skills, and the debtor’s health.
• Persistence: The court will look at whether the debtor’s financial situation will persist for a substantial amount of time during the repayment period.
• Good faith: The debtor must establish that they made a good faith effort to repay the student loan.  Evidence of good faith includes trying to find employment and making payments or obtaining a deferment or forbearance if unable to make payments.

Under the totality of the circumstances test, the court will look at relevant facts, such as the debtor’s age, education, assets, obligations to dependents, and mental health. The location of the court will determine which test the court will use. A debtor that is older and establishes that poverty is long-term is more likely to have a student loan discharged by the court.

Filing a Discharge Action

It is necessary to file additional paperwork with the bankruptcy court in order to obtain a student loan discharge. A debtor must file a “Complaint to Determine Dischargeability of Student Loan.” The court will make a separate ruling on this issue. Therefore, it will be necessary to prove your position to the judge. 

When to Hire an Attorney 

If you are filing for bankruptcy and would like your student loan debt discharged, a bankruptcy attorney may be able to help. Because of the complexity of obtaining a discharge of student loan debt, it is best to hire an attorney.