Bankruptcy on Student Loans: How is undue hardship determined?

Filing for bankruptcy has long been considered a last resort for individuals facing overwhelming debt, but for student loan borrowers, it has historically been an even tougher hurdle to clear.

Unlike other forms of debt, student loans are not automatically discharged in bankruptcy proceedings. Instead, borrowers must file an adversary proceeding and prove that repaying their loans would result in undue hardship.

In recent years, the Department of Education and the Department of Justice have adjusted policies to streamline the process and improve accessibility for borrowers who genuinely cannot afford their loan payments.

While the legal standards remain strict, more individuals may now qualify for relief under revised guidelines.

How Courts Decide if Student Loans Can Be Discharged

There is no single universal test for determining undue hardship, but bankruptcy courts typically evaluate cases based on three critical factors.

1. Inability to Maintain a Minimal Standard of Living - The borrower must demonstrate that making payments would prevent them from affording basic necessities, such as food, shelter, and medical care.
2. Long-Term Financial Struggles - Courts assess whether the borrower's financial difficulties are temporary or long-term. If circumstances (such as chronic illness or permanent disability) indicate that hardship will persist for most of the repayment period, it strengthens the case for discharge.
3. Good Faith Effort to Repay - Borrowers must show that they have made reasonable attempts to repay their loans before filing for bankruptcy. This can include applying for income-driven repayment plans, making partial payments, or seeking loan modifications.

What Happens If the Court Grants Loan Discharge?

If a bankruptcy court determines that the borrower meets the undue hardship criteria, they may receive relief in one of the following forms:

1. Full Discharge - The borrower is completely relieved of student loan debt, and all collection activities cease.
2. Partial Discharge - The borrower remains responsible for a portion of the loan but receives some relief.
3. Modified Repayment - The court may order the borrower to continue making payments but on adjusted , such as lower interest rates or extended repayment periods.

What If the Court Denies Loan Discharge?

If the bankruptcy court does not approve the discharge request, borrowers are still not without options. Many loan repayment programs can help lower payments and make repayment more manageable:

• Income-Driven Repayment (IDR) Plans - Adjusts monthly payments based on income and family size.
• Forbearance or Deferment - Allows temporary suspension of payments due to financial hardship.
• Public Service Loan Forgiveness (PSLF) - Offers loan forgiveness after 120 qualifying payments for borrowers working in public service or nonprofit jobs.

Borrowers should their loan servicer or to the My Federal Student Aid portal to explore available options.

Recent Policy Changes That Affect Student Loan Bankruptcy Cases

In November 2022, the Department of Justice (DOJ) and the Department of Education introduced updated guidelines for handling student loan discharge requests in bankruptcy cases. The goal was to make the system more transparent and accessible for borrowers with legitimate financial hardship.

Some of the key updates include:

• Reducing the Burden on Borrowers - Courts now allow the use of an attestation form to simplify documentation requirements, reducing the need for extensive legal paperwork.
• Encouraging Loan Holders to Discharge When Warranted - Loan servicers are now expected to recommend discharge in cases where borrowers clearly meet the undue hardship criteria.
• Ensuring Consistency in Evaluations - The revised guidelines apply to Direct Loans, FFELP Loans, and Perkins Loans, ensuring a uniform standard regardless of the loan holder.

Additionally, in August 2024, the Department of Education further revised policies regarding legal costs associated with bankruptcy cases. Loan servicers can now concede discharge if the cost of opposing the case in court exceeds one-third of the remaining loan balance.

Legal Framework: The Brunner Test vs. Totality of Circumstances Test

Bankruptcy courts use two main legal tests to determine if a borrower qualifies for student loan discharge:

• The Brunner Test (Used in most federal courts): Borrowers must prove they cannot maintain a basic standard of living while making loan payments. The hardship must be long-term and likely to persist for most of the repayment period. The borrower must have made good faith efforts to repay the debt.
• The Totality of Circumstances Test (Used in the Eighth Circuit and select other jurisdictions): The court considers all relevant factors in a borrower's financial situation to determine if repaying the loan is an undue burden.

Should You File for Bankruptcy to Discharge Student Loans?

Before pursuing bankruptcy as an option, borrowers should carefully weigh the financial and legal consequences:

• Bankruptcy Can Be Expensive - Legal fees and court costs can add up quickly, making it crucial to consult an experienced bankruptcy attorney.
• It Affects Credit for Up to 10 Years - A bankruptcy filing remains on credit reports, impacting future borrowing ability.
• Alternative Repayment Plans May Be Available - Income-driven repayment plans and forgiveness programs might provide relief without the legal hurdles of bankruptcy.

While student loan discharge through bankruptcy remains difficult, recent legal adjustments have opened doors for more borrowers struggling with overwhelming debt. By understanding how courts evaluate undue hardship, borrowers can make informed decisions about their financial future.

If you're struggling with student loan debt, consulting a bankruptcy attorney or financial advisor is recommended. Additionally, the My Federal Student Aid portal offers resources to explore repayment plans and forgiveness options tailored to individual needs.