New Year Resolution #11: Find Out Whether Bankruptcy Can Help with Your Student Loans

Although it’s hard to get rid of student loans through bankruptcy, it’s worth knowing whether and how it can help.

 

What it Takes to “Discharge” a Student Loan

You may have heard that student loans can’t ever be written off in bankruptcy—that is, “discharged.” That’s not true. Certain types of debts can’t ever be discharged, like unpaid child support. Student loans are more like income taxes, which can be discharged under certain conditions.

But income taxes are generally easier to discharge than student loans—you just have to wait a certain amounts of time after the applicable tax return was legally due to be filed and after the tax return was actually filed. Except in situations involving tax evasion, the requirements for discharging a tax debt are quite “black and white.”

Discharging student loans involves a much “grayer” requirement: that the student loan causes an “undue hardship” for the person owing the student loan and for his or her family.  

What “Undue Hardship” Means

Those two words in the Bankruptcy Code are clearly unclear!

Judges are sometimes criticized for “making laws” when they rule on a case, but that’s they are often called to apply laws that are vague. “Undue hardship” is a good example of statutory vagueness. Bankruptcy judges have had no choice but to try to apply this vague language to the cases that have to rule on.

In particular the judges have had to answer the following key question: since Congress said that mere “hardship” was not enough reason to discharge a student loan, what more beyond “hardship” is needed to create an “undue hardship”?

Over the decades since “undue hardship” was put by Congress into the Bankruptcy Code, bankruptcy judges and other federal judges have come to generally agree that for a debtor to show that a student loan creates an “undue hardship,” three requirements have to be satisfied:

1. The debtor must currently be unable to maintain even a minimal standard of living if he or she had to make the required payments on the student loan.

2. This current inability to maintain a minimal standard of living if the student loan were paid must be expected to continue over all or most of the repayment period of the student loan.

3. Earlier, the debtor must have acted responsibly in having made a real effort to pay on the student loan, and/or having tried to qualify for any available forbearances, debt consolidations, and administrative payment-reduction programs.

Notice that these three refer to the present financial condition of the debtor, a projection into his or her future condition, and also how responsibly he or she dealt with the student loan debt in the past. That’s a lot to read into “undue hardship.” But it’s what the current requirements are, pretty much throughout the country.

Choice #1: “Undue Hardship” Now

You might be able to meet these three requirements right now. If so, you could file a Chapter 7 “straight bankruptcy” case or a Chapter 13 “adjustment of debts” case, whichever is better for you as to your other debts, and then formally ask the bankruptcy court for an “undue hardship” of the student loan. A separate legal proceeding would determine whether you meet the requirements. Assuming that the creditor on the student loan would object to its “hardship discharge,” there could be trial focusing on whether you qualify.

Choice #2: “Undue Hardship” Later

You may not be able to meet the three requirements now, but hope or expect to do so at some point in the future. You may have a deteriorating medical condition which is expected to decrease your income and/or increase your expenses in the future. Or you may be approaching a period of lower income, such as upon retirement. Or you may even need to takes some action now to show later that you have met the third requirement. Or you may have some combination of these.

If you believe you would qualify for “undue hardship” later, you have two possible ways to go.

You can file a Chapter 7 case now, complete it in the usual three or four months, and then at the time you believe you would qualify for “hardship discharge” ask the bankruptcy court to re-open the Chapter 7 case and then make your formal request for the discharge of the student loan.

Or, especially if you believe you would qualify for “hardship discharge” within three or four years, file a Chapter 13 case—which usually lasts between three and five years—and make your formal request for the discharge of the student loan before that Chapter 13 case is finished.

There are advantages and disadvantages of these two options as to the rest of your financial life and as to the student loan.

One possibly important consideration is that under Chapter 13 you are protected from collections by the student loan creditor throughout the life of the multi-year Chapter 13 case. In contrast, under Chapter 7 your protection ends when the case is competed, again usually only three or four months after it is filed. So you will likely be subject to the often aggressive collection efforts of the student loan creditor while you wait until you would qualify for “undue hardship.” A Chapter 13 case you could avoid that for years.

Choice #3: No Undue Hardship Expected

Even if you did not expect to meet the quite tough three-pronged test now or in the next few years, you may still benefit from being protected from student loan collections during the years of a Chapter 13 case.

You generally don’t want to evade a student loan debt for years without having a game plan. Otherwise you could just end up owing a whole lot more with all the interest that would accrue during those years. But putting your student loan(s) on hold may make sense if you are thinking that you might possibly qualify for “undue hardship” later (even if you are not confident that you will). Or by the time you finish your Chapter 13 case you could be beyond the reach of collections (by having no more income). Or you may simply feel you have no choice but to first address other more pressing debts to be paid through your Chapter 13 plan (such as to save your home or vehicle, to deal with income tax debts or a child/spousal support arrearage).