Discharging Student Loans in Chapter 7 Bankruptcy: Navigating the Undue Hardship Standard

Student loan debt has become a significant burden for many Americans. While bankruptcy is often considered a last resort, it can provide a path to financial relief. This article explores the possibility of discharging student loans in Chapter 7 bankruptcy, focusing on the "undue hardship" standard and recent guidance from the Department of Justice (DOJ) and the Department of Education.

The Challenge of Discharging Student Loans

Unlike most other debts, student loans are not automatically discharged in bankruptcy. Bankruptcy law provides that student loan debt can be discharged in bankruptcy if paying back the loan would cause "undue hardship." To eliminate student loan debt, a separate legal process called an adversary proceeding must be filed within the bankruptcy case. It is difficult, but not impossible to discharge student loan debt in bankruptcy. You can discharge federal and private student loans in bankruptcy.

Understanding the "Undue Hardship" Standard

To discharge student loan debt in bankruptcy, you must demonstrate that repaying the debt would result in an undue hardship. The phrase “undue hardship” is the legal benchmark used by bankruptcy courts to determine whether a borrower qualifies for student loan discharge. The test for deciding what constitutes an undue hardship varies between courts. This requires an intensive factual investigation. The result has been varying results and extreme difficulty in discharging student loans.

Most courts use the Brunner Test, a legal test that was developed in case law, to determine whether student loans are dischargeable in a given case. Many courts look at an undue hardship as an all-or-nothing proposition. While there are several tests courts use to decide what constitutes an undue hardship, courts are almost always reluctant to discharge student loan debt.

The Brunner Test: A Common Standard

Many courts use the Brunner test to determine what qualifies as an undue hardship. Most Texas courts will use the Brunner Test (named after the legal case that first set this standard) to make the decision whether you would suffer undue hardship under the law. Under this test, a person is capable of discharging a debt if certain factors are met. The Brunner Test is the legal standard that Maryland bankruptcy courts use to determine whether student loans can be discharged. The Brunner Test is a three-part standard for undue hardship:

Inability to Maintain a Minimal Standard of Living: A person must establish that they are incapable of maintaining a minimal standard of living if they are required to repay loans. This means demonstrating that making loan payments would prevent you from affording basic necessities like housing, food, clothing, and transportation. Present Ability to Pay: if you’re forced to repay your student loans, will you be able to maintain a minimal standard of living? The first element of the standard usually involves the lowest monthly payment available to the borrower, namely the monthly loan payment under Income Contingent Repayment, as opposed to standard ten-year repayment. (With the introduction of Income Based Repayment on July 1, 2009, it is expected that the courts will switch to this repayment plan as it usually yields a lower monthly payment and meshes well with the 150% of poverty line threshold for a bankruptcy fee waiver.) Note that if the borrower has multiple student loans and could afford to repay some but not all of them, the court will generally discharge only those loans that exceed the borrower’s ability to repay. It is also possible that a court will discharge part of a loan instead of the entire loan.
Persistence of Financial Hardship: A person must establish that their current financial situation is likely to continue for a substantial portion of the repayment period. You must show that your situation is unlikely to improve significantly over the life of your loans. Future Ability to Pay: can you show that your hardship will continue for a significant amount of the time left on repaying your loans? The second element of the standard requires the debtor to provide evidence of additional exceptional circumstances that are strongly suggestive of a continuing insurmountable inability to repay, such as being disabled or having a disabled dependent. A serious physical or mental illness might also qualify. An inability to work in one’s chosen profession does not necessarily preclude being able to work in another field. There must be a “certainty of hopelessness”, meaning that there is no chance of any future improvement in the borrower’s financial situation.
Good Faith Effort to Repay: Have you made good faith efforts to repay your student loans before filing for bankruptcy? The third element of the standard requires the borrower to have demonstrated a good faith effort to repay the loans. Filing for a bankruptcy discharge immediately after graduation is generally not considered a good faith effort to repay the loans. However, there might be extenuating circumstances, such as the debtor suffering brain damage in a car accident shortly after graduation. The court will consider the totality of the circumstances. The court will consider whether the debtor made payments on the loans when he or she had some income available and obtained a deferment or forbearance when his or her income was insufficient. The court will also consider whether the debtor took advantage of various alternatives to bankruptcy, such as the extended repayment, income-contingent repayment and income-based repayment plans, and whether the debtor tried to increase available financial resources, such as seeking a better job and reducing expenses.

Proving all three parts of the Brunner Test can be challenging, and outcomes can vary by jurisdiction.

The Totality of the Circumstances Test

Although most courts use the Brunner Test to determine if student loan debt is dischargeable in Chapter 7, a few courts will use the more lenient Totality of the Circumstances Test. Other Tests. There are some other tests used to assess what constitutes an undue hardship.

Recent Guidance from the Department of Justice and Department of Education

In recent years, federal courts and lawmakers have shown increased flexibility in how they interpret the undue hardship standard. The law has not changed, but enforcement has. In 2022, the Department of Justice and the Department of Education issued new guidance to streamline the evaluation process and create a more consistent standard for discharging federal student loans in bankruptcy.

The Department of Justice and the Department of Education released new guidance for the government in handling requests to discharge federal student loans in bankruptcy effective November 17, 2022. In most cases, your student loans will survive the Chapter 7 bankruptcy. However, filing Chapter 7 may still be beneficial.

When a debtor files a lawsuit to discharge student loans in the bankruptcy case, the debtor submits a form attestation for DOJ review. The attestation is fact-intensive and addresses all guidance factors. Read the guidance. If satisfied, the DOJ attorney will stipulate to the facts and make a recommendation to the Judge. The recommendation may be discharge, partial discharge, or no discharge. The recommendation is not binding on the Court and the Court may make its own decision.

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At the beginning of the proceeding, the DOJ will ask you to fill out an attestation of undue hardship. The judge’s decision of what to do if you have an undue hardship will also depend on which type of bankruptcy case you file (Chapter 7 or Chapter 13).

Chapter 7 vs. Chapter 13 Bankruptcy

In a Chapter 7 bankruptcy, you are asking a judge to cancel all of your debt, but you have to have income below a certain amount in order to qualify. If you are filing a Chapter 7 bankruptcy with no assets, you may still be able to discharge other debts, even if your student loans remain.

In a Chapter 13 bankruptcy, you usually ask the judge to help you reorganize and lower your debt. In Chapter 13 bankruptcy, while student loans still cannot be discharged without meeting the Brunner Test, they can be included in your repayment plan. This means that you can potentially reduce your monthly student loan payments during the three to five year Chapter 13 plan period while the automatic stay is in effect, giving you time to pay some of this student loan debt and other debts.

What to Do If You Are Considering Bankruptcy

If you are in a bankruptcy case, whether 7, 11, 12, or 13, contact your attorney and ask whether your student loans may be eligible for discharge under the new guidance. With recent legal developments, the process is difficult, but it is not impossible. Attempting to discharge student loans in bankruptcy without legal help is risky.

Options for Managing Student Loan Debt Outside of Bankruptcy

Before considering bankruptcy, explore other options for managing your student loan debt:

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Deferment or Forbearance: Deferment and forbearance are ways to temporarily postpone, lower, or stop your loan payments for a specific period of time.
Income-Based Repayment (IBR): IBR allows you to lower your monthly payments based on your current income and expenses. Your payments can go up or down each year as your financial circumstances change. To be eligible you must not be in default and show that your payment under the 10 year standard student loan repayment is higher than what you’d pay under IBR. You can stay on the IBR plan even if your financial situation improves.
Consolidation:
Contact Your Lender: Don’t ignore a delinquency notice about your student loans. Contact your lender to work out a repayment plan. Most lenders will work with you, but you have to ask. Get more information from www.studentaid.gov.

Bankruptcy and Eligibility for Financial Aid

Generally speaking, a bankruptcy should have no impact on eligibility for federal student aid. A few years ago students who had their federal student loans discharged through bankruptcy were required to reaffirm the debt in order to be eligible for further federal student aid. But the Bankruptcy Reform Act of 1994 (P.L. 103-394, enacted October 22, 1994) amended the FFELP regulations dealing with loans discharged in bankruptcy. As a result of those changes, a borrower who had FFELP loans previously discharged in bankruptcy is no longer required to reaffirm those loans prior to receiving additional federal student aid.

Title IV grant or loan aid (including the Perkins loan program) may not be denied to a student who has filed bankruptcy solely on the basis of the bankruptcy determination. Financial aid administrators are precluded from citing bankruptcy as evidence of an unwillingness to repay student loans. Schools may nevertheless continue to consider the student’s post-bankruptcy credit history in determining willingness to repay the loan. As long as there are no delinquencies or defaults on student loans currently in repayment, the student should be eligible for additional federal student loans, regardless of any past bankruptcies.

Parents who apply for a PLUS loan (or graduate students applying for a Grad PLUS loan) may be denied a PLUS loan if they have an adverse credit history. The definition of an adverse credit history includes having had debts discharged in bankruptcy within the past five years. If this is the case, the parents may still be eligible for a PLUS loan if they secure an endorser without an adverse credit history. If the parents are turned down for a PLUS loan because of an adverse credit history, the student may be eligible for an increased unsubsidized Stafford loan.

Private loans are an entirely different matter. The student should contact the financial aid administrator at his school for advice on the impact of a bankruptcy on eligibility for private loans. The student should also talk to the lender and provide evidence that he is a good risk, and be prepared to explain the circumstances behind the bankruptcy. The lender may be more willing to issue a loan if the borrower offers to secure the loan. If the student is still having problems, he may want to consult the attorney who handled the bankruptcy.

Most bankruptcies will have an impact on eligibility for private loan programs, including some school loan programs. Many private loan programs have credit criteria that preclude people with a bankruptcy within the past 7 or 10 years from borrowing without a creditworthy cosigner. There are, however, exceptions if the bankruptcy was initiated for reasons beyond the borrower’s control, such as extraordinary medical costs, natural disasters, or other extenuating circumstances.

If a parent went through bankruptcy, it should have absolutely no impact on their children’s eligibility for private loans, unless the parent is required to cosign the loans. If the bankruptcy filing included a payout plan, even if not 100%, the student will be at an advantage in applying for private loans. Bankruptcy filers with a payout plan, especially a 100% payout plan, are a better risk than most people who have gone through bankruptcy. On the other hand, if the borrower went the Chapter 7 route, he may have more difficulty in getting a private loan. Lenders tend to look less favorably on complete liquidations. Thus borrowers who filed for a Chapter 11 (or Chapter 13) and had a payout plan will be more likely to get a private loan than borrowers who filed a Chapter 7.

Lenders also look at whether the borrower is able to refile for bankruptcy. Chapter 11 filers cannot immediately refile again for bankruptcy. Although any lender should know this, they may need to be reminded. Chapter 7 files are prohibited from refiling a Chapter 7 bankruptcy for 6 years. However, Chapter 13 plans have no such restriction, so a debtor can file a Chapter 7 bankruptcy, have their debts discharged, and then file a Chapter 13 within a very short time if new debt is incurred. A debtor can file an unlimited number of Chapter 13 bankruptcies.

Federal vs. Private Loans

There are two primary types of student loans: federal and private. Private Loans typically have fewer repayment options, and some may not qualify for the full range of federal protections.

Thus FFELP and FDSLP loans, and education loans funded or guaranteed by private nonprofit organizations, are automatically nondischargeable in a bankruptcy proceeding. The only cases in which they can be discharged through bankruptcy are: if the borrower files an undue hardship petition and then it is up to the judge to decide whether the loan can actually be discharged.

Section 220 of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), P.L. 109-8, extended similar protections to “qualified education loans” starting on October 17, 2005, even when they are not funded or guaranteed by a nonprofit organization.

Qualified Education Loans

Qualified education loans is defined to include any debt incurred by the taxpayer solely for the purpose of paying for qualified higher education expenses of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer. (Dependency is determined as of the time the taxpayer took out the loan.) Interestingly enough, most private student loan programs seem to have some sort of nonprofit involvement.

So to qualify for this exception, the private student loan must be capped at the cost of attendance minus student aid, such as scholarships, and expenses paid for using amounts from employer tuition assistance, 529 college savings plans and prepaid tuition plans, US savings bonds and Coverdell education savings accounts. If a borrower were able to show that the loan exceeded the limits set by IRC section 221(d)(2), they might be able to argue that the loan was ineligible for bankruptcy protection and so should be subject to discharge. See IRS Tax Topic 456 and IRS Publication 970 for further IRS guidance on what types of expenses qualify, such as the requirement that the expenses must have been “paid or incurred within a reasonable time before or after you took out the loan” (per IRC section 221(d)(1)(B)). IRS Publication 970 provides a safe harbor of 90 days before and after the academic period to which the expenses relate.

Consolidation loans and other loans used to refinance a qualified education loan also qualify, provided that there was no cash out from the refinance (or that the cash out was used solely for qualified higher education expenses). Eligible student is defined by IRC section 25A(3) as a student enrolled at least half time in a degree or certificate program at a Title IV institution (per Section 484(a)(1) of the Higher Education Act of 1965).

Other Circumstances for Student Loan Discharge Without Bankruptcy

Can I discharge my student loan without declaring bankruptcy? ONLY IF:

If you are totally and permanently disabled and as supported by medical evidence.
If your school falsely certified to the Dept.
If it closes while you are enrolled or up to 120 days after you withdrew, your loans will be discharged. You are eligible if you have not completed your program of study, even if you received a diploma or certificate before the program’s completion. You will need to contact them if you have nonfederal loans through private lenders. You will have to fill out a Closed School Loan Discharge Application. Your last attendance date should be the same as when your school closed.
Yes. The Direct Loan Program offers a 100% discharge of the remaining outstanding balance on your eligible Direct Loan after you have completed 120 monthly payments while employed full-time in a public service job.

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