While generally speaking you cannot obtain a discharge of student loans by filing bankruptcy, there is an exception to the general rule. Bankruptcy law does provide that a student loan may be discharged if to continue to pay it would cause the debtor “undue hardship”. The same basic rule also applies to Chapter 7 as well as Chapter 13 Bankruptcy cases.
Question: Does this apply to government as well as private student loans?
Answer: In 1998, Congress enacted The Higher Education Amendments to the U.S. Bankruptcy Code. These amendments made student loans non-dischargeable in bankruptcy, unless the debtor is successful in claiming that repaying the loans would lead to substantial hardship. Then, in October, 2005, the law was extended to include private student loans.
Section 220 of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 extended protections similar to those governmental loans to “qualified education loans” even when they are not funded or guaranteed by a nonprofit organization.
Question: What is a qualified student loan?
Answer: Qualified education loans are defined by the statutes to include any debt incurred by the studebt solely for the purpose of paying for qualified higher education expenses of the student, the student’s spouse, or any dependent of the student.
Generally speaking, tuition bills and other expenses not evidenced by a promissory note are not defined as qualified education loans and can be discharged in bankruptcy.
However, an unpaid tuition bill will be considered an education loan only evidenced by a promissory note. Whether this extends to a tuition installment plan is not clear. In most cases the college arranges with a third party to process the billing and payments. Yet most of these companies specifically state that the tuition installment plan is not a loan.
It is wise to remember that a college may withhold official transcripts while bills are outstanding. However, as soon as the student files bankruptcy the college may no longer withhold transcripts during the pendency of the case. Additionally, if the debt is discharged, the college can no longer refuse to provide an official academic transcript.
Question: How do I show hardship?
Answer: Basically, a student loan can only be discharged if the bankruptcy court is convinced that paying back the loan would cause undue hardship for the student or the student’s dependents. A hardship discharge is not automatically determined. The student must file a petition (adversary proceeding) to get a determination.
Three criteria would be used to make that determination:
1. If the student is forced to continue paying the student loans, will it prevent the student from maintaining a minimal standard of living?
2. Will that difficulty persist over the repayment period?
3. Was there a good faith effort made to repay the loan before filing bankruptcy?
Courts in different parts of the country use different tests to evaluate whether there is undue hardship. While the elements are basically the same, some courts are more flexible, some less.
If the student is successful in proving undue hardship, the student loan will be completely canceled.
Question: What if I cannot show hardship?
Answer: Even if you are unable to discharge your student loan debt by filing bankruptcy, there are other options, including deferments and cancellations.
You may be able to file a chapter 13, or “reorganization.” This would allow you to get caught up by modifying the size of your student loan payments. During the period of the plan, usually three to five years, you make the payments as set forth in that plan. When you come out of bankruptcy, you can try to discharge the loan balance based on undue hardship. While you are repaying through the bankruptcy court, there will be no collection actions taken against you.
Regardless of whether the loan is dischargeable, the student should object to the lender’s claim in a Chapter 13 proceeding. The creditor would then need to provide an accounting of the amount owed. The burden of proof is on the lender, not the debtor and may result in a judge determining that there is actually a lesser amount owed than is claimed by the lender.
Question: If I receive a discharge of my student loans due to hardship, can I ever get new student loans?
Answer: The answer to this question is not simple because several issues are involved. It depends on whether the student loan program is federal or private, the type of loan and the type of bankruptcy. Although bankruptcy discharges should not affect your ability to get new federal loans and grants, PLUS loans, for example, are an exception. As long as there are no delinquencies or defaults on current student loans, the student should be eligible for additional federal student loans.
However, a prior bankruptcy will very likely affect your ability to get a private student loan. Private student lenders almost always use credit scores to evaluate loan applications. The school’s financial aid administrator should be able to give the student advice on the impact of a bankruptcy on eligibility for private loans.