Student loan debt has become a serious problem in the United States. According to the Federal Reserve Bank of New York, approximately $85 billion in educational debt is past due. With so many in default on their loans, borrowers are looking for ways to repay or discharge their debt, and many are looking to bankruptcy as a solution.
The general rule is that student loans cannot be discharged in bankruptcy. However, there are exceptions to this rule. The Bankruptcy Code states that educational loans that are federally backed or where the funds originated from a non-profit agency are not discharged in bankruptcy. Private loans can be discharged but these types of loans are a small percentage of the educational loans given each year.
Debtors can discharge educational loans in Chapter 7 bankruptcy cases by claiming undue hardship in a separate lawsuit filed in the bankruptcy court. These lawsuits are called adversary proceedings. The definition of undue hardship is slightly different depending upon where the bankruptcy case is filed. Many courts follow the Brunner Test.
The Brunner Test is a three-part test for determining dischargability of this type of debt. First, the debtor must prove that repayment of his school loans would be an undue hardship on himself and his dependents. This means showing that the debtor cannot maintain a minimal standard of living while repaying any portion of the educational loans. Second, the debtor must prove that the circumstances that created the undue hardship are permanent and unlikely to change. Third, the debtor must show that he has made a good faith effort to repay the loans. Courts also consider whether the circumstances that created the undue hardship were present at the time the money was borrowed. Very few debtors meet the criteria necessary for discharging student loan debt in bankruptcy.
If student loans cannot be discharged then they have to be paid. Treatment of these claims is different depending upon whether the case is filed under Chapter 7 or Chapter 13. In Chapter 7 cases repayment of student loans is deferred during the bankruptcy case. Once the case is closed the lenders are free to begin collecting from the debtor. In Chapter 13 cases student loan creditors are treated as unsecured creditors. They receive payment only if the debtor's confirmed plan provides payment to the unsecured creditors as a class. However, if the student loans are not paid in the bankruptcy case then payment is simply deferred until the case is closed. During the case the debt continues to accrue interest, so the balance can be substantially larger when repayment begins after the bankruptcy case.
