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Discharge of student loans in bankruptcy complicated…and rare

Student loans have traditionally not been viewed as a dischargeable debt in bankruptcy courts. But as more students borrow more money to further their educations while the unemployment rate has risen, courts have begun to look at individual circumstances to determine whether student loan debt should be forgiven in light of the borrower’s total circumstances. As further guidance to bankruptcy courts, the United States Department of Education recently released new guidelines addressing criteria for making these decisions.

Obviously, the lenders would like to recoup the money they loaned, but one prong of the new guidance requires lenders to evaluate the cost of the litigation involved in recovering the debt. If the costs to pursue the recovery exceed one-third of the amount owed on the loan (including many of the fees that normally accrue as the loan goes unpaid such as interest and collection costs), the lender may accept or choose to not oppose the undue hardship assertion.

While the Bankruptcy Code itself does not define “undue hardship” in this context, federal courts, which govern bankruptcy law throughout the states including in Kentucky, have weighed in. The courts have used two different tests in their analysis of proof of undue hardship.

The “Brunner” test requires three things to be proven by the debtor:

  • he or she cannot maintain a minimal standard of living if forced to repay the loans;
  • those circumstances will persist for a significant portion of the scheduled repayment of the loans; and
  • good faith repayment efforts have been made.

The other test, “Totality of the Circumstances,” examines the following to relieve the debt:

  • financial resources of the debtor (past, present and future);
  • required reasonable living expenses; and
  • other relevant facts and circumstances.

Both tests are obviously subject to broad interpretation. In fact, shortly before the guidance was issued, one woman who is unemployed and disabled living below the poverty line was denied her request to cancel her loans in bankruptcy because, in the court’s opinion, she had not made a good-faith effort to repay the loans. Her loan balance had almost tripled due to interest, but the court suggested other avenues of debt relief such as federal consolidation programs.

Given the numerous vague factors required to prove a need to discharge student loans, having the advice of an experienced bankruptcy attorney will be valuable when trying to navigate the bankruptcy process for debt relief.

Source: Bloomberg, “Courts Rule That Disabled Woman Living Below the Poverty Line Must Repay Student Loans,” Bill Rochelle and Natalie Kitroeff, June 22, 2015

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