Bankruptcy and Student Loans

Understanding the relationship between bankruptcy and student loans.

Student Loan Interest Rates May Increase Soon.

Congress is currently at war over student loan interest rates. Interest rates on Stafford loans will double soon if congress doesn’t act. But although no one seems to want this to happen, the parties can’t agree on what to do about it. This is an important issue for people considering bankruptcy because student loan debt is more difficult to avoid than other debts.

Even if You File Bankruptcy, You May Still Have to Repay Your Student Loans.

Bankruptcy discharges many of an individual’s outstanding debts. When a debt is discharged, the debtor does not have to repay it. However, bankruptcy law makes an exception for student loan debt. Student loan debt will only be discharged under special circumstances.

Section 523(a)(8) of the US Bankruptcy Code provides:

(8) unless excepting such debt from discharge under this paragraph would
impose an undue hardship on the debtor and the debtor’s dependents,
for–

(A)(i)
an educational benefit overpayment or loan made, insured, or guaranteed
by a governmental unit, or made under any program funded in whole or in
part by a governmental unit or nonprofit institution; or

(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as
defined in section 221(d)(1) of the Internal Revenue Code of 1986,
incurred by a debtor who is an individual;

This section means that student loans will only be discharged when requiring the individual to repay them would impose an undue hardship on the debtor or the debtor’s dependents. The question then is – what counts as an “undue hardship”?

There is no statutory definition for “undue hardship.” Courts have had to define the term themselves, and different jurisdictions have developed different hardship standards. Generally, courts look at factors such as the finances available to the debtor as they are filing bankruptcy, the debtors’ likely future earnings, and the financial needs of the debtor’s family, among other things. In New York, courts follow the test set out in Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (2d Cir. 1987). In this case the court asked three questions. First, would requiring the debtor to repay the student loan debts put the debtor, or the debtor’s dependents, below a minimal standard of living? Second, is this financial situation likely to persist for the rest of the loan repayment period? Third, has the debtor made good faith efforts to repay the loans? A New York court is only likely to discharge a student loan debt if these questions are answered in the affirmative.

While the factors to be considered may vary from one jurisdiction to another, courts generally agree that the hardship must be “undue” – that is, beyond “ordinary” or “garden variety” hardship. The point is that student loans will only be discharged under extraordinary circumstances.

If you have questions about student loans, bankruptcy, or other legal issues, the Law Firm of Vaughn, Weber & Prakope, PLLC is here to help. Call us at (516) 858-2620 to set up a free consultation.