It's one of the most intensely-debated student loan questions: Can you discharge your student loans in bankruptcy?
The short answer: normally, student loans are not dischargeable. However, that may change.
Here's what you need to know - and why.
Student Loans & Bankruptcy: Overview
First, a quick overview. As many borrowers struggle to repay ballooning student loan debt, bankruptcy is one option that gets floated.
According to Make Lemonade, there are more than 44 million borrowers who collectively owe $1.5 trillion in student loan debt in the U.S. The average student in the Class of 2016 has $37,172 in student loan debt.
Student loans are now the second highest consumer debt category - behind mortgages, but ahead of credit card debt.
Unlike other consumer debt such as credit card and mortgage debt, however, student loans traditionally cannot be discharged in bankruptcy.
Why? Some can't explain the rationale for the student loan "no bankruptcy" exception, but others say it grew from a concern that student loan borrowers could take advantage of bankruptcy laws, borrow a bunch of debt, earn a degree and then file for bankruptcy.
There are exceptions, however, namely if certain conditions regarding financial hardship are met.
The Brunner Test: Financial Hardship
Those conditions are reflected in the Brunner test, which is the legal test in all circuit courts, except the 8th circuit and 1st circuit. The 8th circuit uses a totality of circumstances, which is similar to Brunner, while the 1st circuit has yet to declare a standard.
In plain English, the Brunner standard says:
- the borrower has extenuating circumstances creating a hardship;
- those circumstances are likely to continue for a term of the loan; and
- the borrower has made good faith attempts to repay the loan. (The borrower does not actually have to make payments, but merely attempt to make payments - such as try to find a workable payment plan.)
There are variances across federal districts, but that’s the basic framework.
How Do You Discharge Student Loans In Bankruptcy?
In order to have a student loan discharged through bankruptcy, an Adversary Proceeding (a lawsuit within bankruptcy court) must be filed, where a debtor claims that paying the student loan would create an undue hardship for the debtor.
Were Student Loans Ever Dischargeable In Bankruptcy?
Yes. Prior to 1976, you could discharge your student loans in bankruptcy.
Congress then changed the law: student loans were dischargeable if they had been in repayment for five years. Subsequently, that period was extended to seven years.
In 1998, Congress removed dischargeablility except if a debtor could show that paying back the student loans would create an undue hardship. In 2005, Congress extended this protection to private student loans.
So, What's Changed Now?
According to the Wall Street Journal, which spoke to more than 50 current and past bankruptcy judges appointed during both Democratic and Republican administrations, some judges may be more open to helping debtors.
Does that mean the floodgates are now open and student loans can be discharged in bankruptcy?
That said, some judges are looking at ways to help alleviate the burden. Examples, per the Wall Street Journal, may include:
- encouraging bankruptcy attorneys to represent debtors at no cost
- potentially eliminating future tax bills that be linked to student loan debt relief or debt cancellation after 25 years through federal student loan repayment programs
- cancelling private student loan debt from unaccredited schools
- allowing student loan borrowers to make full payments during the Chapter 13 debt repayment period (which can last five years)
While these tactics may be welcomed by some student loan borrowers, critics may question whether judges should actively try to circumvent the existing law (suggesting that Congress, and not judges, should make the law).
Since the vast majority of student loan debt outstanding is comprised of federal student loans, any cancellation of federal student loan debt would be at the federal government's (and taxpayer) expense.
What Else Can You Do If Your Struggling To Make Student Loan Payments?
Here are two strategies:
1. Income-Driven Repayment: For federal student loans, consider an income-driven repayment plan such as IBR, PAYE or REPAYE. Your payment is based on your income, family size and other factors, and is typically lower than the standard repayment plan.
After a certain period of time (such as 20 or 25 years, for example), your federal student loans (not private student loans) can be forgiven. However, you likely will owe income taxes on the amount of your student loans that are forgiven.
2. Pay Off Other Consumer Debt: If you have other high interest debt such as credit card debt, consider paying off this debt first (particularly if the interest rate is higher than your student loan interest rate). This can free up cash that can be applied to student loan debt reduction.
You can also consider a personal loan to pay off your credit card debt. Credit card consolidation is the process of paying off your existing credit card debt with a single personal loan at a lower interest rate.
If you can borrow a personal loan at a lower interest rate than your credit card debt, you can save in interest costs and also potentially improve your credit score.