Discharge Student Loans in Bankruptcy

Filing for Bankruptcy To Discharge Your Student Loans

Filing for bankruptcy in order to discharge student loans is a complex process, but for those overwhelmed by student loan debt, it may be the best option for finding financial relief. Whether you are exploring your options for debt relief or simply want to understand the process of wiping out your student loans with a bankruptcy discharge, you should consult an attorney first.

In this article, I explain the basics of filing for bankruptcy, including eligibility requirements, the type of student loans that can be discharged in bankruptcy, and the steps to take when considering this option. Understanding bankruptcy law can help you make informed decisions about your student loans.

Introduction To How Student Loan Bankruptcy Works

A bankruptcy filed in order to discharge a student loan is a complicated process that involves first filing for either Chapter 7 or Chapter 13 bankruptcy. In order to qualify for student loan discharge, the student loan borrower must file an “adversary proceeding” in bankruptcy court, where they must prove that repaying the loan would cause undue hardship

Before filing bankruptcy, the debtor should exhaust all payment options for his or her student loans, including deferment or repayment plans. Additionally, being past-due on student loans or even defaulting on them, are factors to consider before pursuing bankruptcy in general.

Filing for bankruptcy can have a significant impact on credit and financial life, as it stays on credit reports for 10 years in the case of Chapter 7. However, an individual must weigh that against his or her current credit situation with past due or defaulted student loans.

What Is Chapter 7 Bankruptcy?

In Chapter 7, a individual debtor obtains a discharge of all debts, except for specified debts in Section 523 of the Bankruptcy Code. A discharge is a court order releasing the debtor from his or her debts. In other words, the debt is wiped out and the debtor no longer owes the creditor any money. A Bankruptcy Trustee [appointed by the court] administers the case and determines if the debtor has assets or no assets to pay creditors.

An individual debtor usually does not have assets that the trustee liquidates because they are “exempt” under California exemption statutes for cases filed in California.

As an individual debtor, you may keep your home, personal items, household goods, bank accounts, jewelry, and car in Chapter 7 bankruptcy. You may also keep your employee pension plans, 401k, and IRA when filing for Chapter 7. The trustee will sell off your assets which are not properly exempted under state law, in this case California law. The tabulation of your exemptions should be made prior to bankruptcy filing by an attorney capable of applying the California exemptions to your assets. 

Current bankruptcy law applies a “means test” of the debtor’s income. An individual’s gross monthly income should not exceed the median income of California, or the state of residence, as specified in the census data of the Department of Justice. If current monthly income is equal to or below the state median income, then you may file a Chapter 7 bankruptcy or Chapter 13. Read more about the “Means Test”…

What Is Chapter 13 Bankruptcy?

In Chapter 13, an individual debtor proposes and completes a plan to repay his or her creditors over three to five years. The plan in Chapter 13 is sometimes referred to as a “Wage Earner Plan.”

The Chapter 13 plan provides that debtor’s monthly payments specified by the plan itself are forwarded to a Chapter 13 Trustee, who then disburses the payments each month and ensures each creditor is paid. Read more about the Chapter 13 Plan…

The Chapter 13 Trustee will take debtor’s monthly payment and disburse that money to the debtor’s creditors according to whether the creditors are secured (auto loan), unsecured (credit card), or priority (taxes) creditors. The court must approve of the Chapter 13 plan, and the bankruptcy code has strict requirements for approval. When a debtor has completed all payments called for by his or her Chapter 13 plan, then the debtor obtains a Chapter 13 discharge. Read more about who may be a debtor in Chapter 13.

Discharge of Debts

Whether an individual files for Chapter 7 or Chapter 13 as discussed above, the Bankruptcy Code provides that certain types of debts cannot be discharged. These special debts are provided under Bankruptcy Code Section 523. One such debt that cannot be discharged is a government student loan “unless excepting such debt from discharge would impose an undue hardship on the debtor and the debtor’s dependent.”

Therefore, a student loan may be discharged if the debtor proves in the Chapter 7 or Chapter 13 that the student loan is an undue hardship on the debtor and debtor’s dependent.

What Constitutes “Undue Hardship”

When it comes to student loans, courts use different tests to determine if a borrower is facing undue hardship. The most common tests are the Brunner test and the “totality of circumstances test.” The Brunner test, used in most circuits, requires the borrower to prove three factors:

(1.)The inability to maintain a minimal standard of living,

(2.) The existence of additional circumstances that prevent the borrower from repaying the loan, and 

(3.) The good faith efforts of the Debtor to repay the loan in the past.

The second test, the “totality of circumstances test,” considers all relevant factors in a borrower’s financial situation to determine if repaying the student loan would create undue hardship.

To meet the undue hardship standard, factors such as low income, permanent disability, and the likelihood of continued financial hardship must be proven by the debtor. Examples of circumstances that may qualify include long-term unemployment, significant medical expenses, or disability that prevents the borrower from working.

The standards for discharging student loans in bankruptcy are high. To establish undue hardship, debtors must demonstrate that they cannot maintain a minimal standard of living for themselves and their dependents while repaying the student loans, and that this situation is likely to persist for a significant portion of the repayment period.

How Does Debtor Prove Undue Hardship? Filing an Adversary Proceeding

The individual debtor in either a Chapter 7 or Chapter 13 must file an adversarial proceeding first. The adversarial proceeding is a separate “lawsuit” brought in the Bankruptcy Court during bankruptcy proceedings and is given its own case number and docket. The bankruptcy court does not require a filing fee for the filing of this adversarial proceeding by the debtor.

The adversarial proceeding includes both an adversarial summons and complaint, both of which must be served on the creditor involved. The complaint itself must be properly drafted by the debtor.

The recent simplification of adversary proceeding paperwork has made it easier for individuals to represent themselves in court, potentially increasing the success rate of student loan discharge through bankruptcy.

When to File an Adversary Proceeding for Chapter 7

Complaints to determine a discharge of your federal student loans must be filed soon after the bankruptcy case is filed. The deadline for filing such complaints is specified in the “Notice of Chapter 7/11/13 Bankruptcy, Meeting of Creditors, Deadlines” mailed by the clerk’s office to you and all creditors once the bankruptcy case is filed.

What’s New?

The data show that federal student loan partial or full discharges have been approved in 99% of Cases under new policy. In 2022, the Department of Justice along with the Department of Education approved a new process for determination of discharges for federal student loans. Since then, the Department of Justice has reported as of November, 2023, that this new streamlined process has translated into increasing numbers of eligible federal student loan borrowers seeking and obtaining debt relief under the Bankruptcy Code.

The vast majority of borrowers seeking discharge have received full or partial discharges. In 99% of cases where courts have entered orders or judgments to date, the government recommended, and the court agreed to, a full discharge or partial discharge. 

Two bankruptcy courts — the Northern and Central Districts of California — have adopted procedures recognizing the utility of the new process, aimed at further streamlining the procedures debtors must follow to obtain discharges. Learn more….

This new bankruptcy guidance and process has had a significant impact on struggling borrowers, as it allows for the full or partial discharge of applicable federal student loan debt, providing much-needed relief for those facing financial hardship. Overall, this new policy has provided a lifeline for many borrowers who were previously burdened by their student loan debt, offering a real opportunity for financial recovery and a fresh start.

Conclusion

Bankruptcy can have varying outcomes and impacts on federal student loans. In some cases, student loans may be discharged in bankruptcy, while in other cases, they may not be affected at all. The impact of bankruptcy on student loans depends on the type of bankruptcy and the individual’s specific circumstances. Alternatives for renegotiating loan terms include income-driven repayment plans, loan consolidation, and loan forgiveness programs.

Considering the potential outcomes and impact of bankruptcy, it’s important to weigh the pros and cons. While bankruptcy may provide relief from overwhelming debt, it can also significantly damage credit scores. However, the new streamlined process for substantiating undue hardship in bankruptcy cases may make it easier for individuals to get their student loans discharged.

In conclusion, it’s crucial for individuals with student loan debt to carefully consider their options before filing for bankruptcy. Exploring alternatives for renegotiating loan terms and understanding the potential impact on credit scores are important steps in making an informed decision.

About Author

Keith F. Carr is an attorney practicing Divorce, Estate Planning, and Bankruptcy. Attorney Keith F. Carr has over 30 years experience. Founder of Law Offices of Keith F. Carr, located in San Francisco, San Jose, and Palo Alto, Ca.

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