Student Loan Debt and Bankruptcy

According to the Consumer Financial Protection Bureau, student loan debt in the U.S. is more than $1 trillion. And that number is only rising, as the cost of undergraduate and graduate education is becoming increasingly difficult for individuals and families to pay. In fact, private student loan holders are falling behind on payments or defaulting on their loans twice as often as they did before the recession.

What can you do if your student loans are causing significant financial hardship? Can bankruptcy help? As you have undoubtedly heard in the news recently, you can rarely discharge your student loan debt in Chapter 7 bankruptcy. However, can that debt help you qualify for bankruptcy to relieve some of your other financial strain? This is a question yet to be determined by bankruptcy courts in California, but it is certainly one worth asking.

Is Student Loan Debt Dischargeable?

During Chapter 7 bankruptcy, a bankruptcy trustee collects a debtor’s nonexempt property to pay back creditors (usually, the debtor keeps all of his or her property because it is considered “exempt”). After this “liquidation” is complete, the court discharges most of the remaining debt. This means that the debtor is no longer personally liable for his or her debts.

However, there are some debts that are not dischargeable, such as student loan debt. Student loans have not been fully dischargeable since 1976, when the Higher Education Act was amended to require debtors to wait five years or show undue hardship to discharge their student loans. Then, the Bankruptcy Code was amended to make student loan debt non-dischargeable in its entirety, unless a debtor is able to show undue hardship.

How can you prove undue hardship? Most courts will look at the debtor’s standard of living. Is the student loan debt making it impossible for the debtor to maintain a minimal standard of living over the majority of the loan repayment period? Has the debtor tried (made a good faith effort) to pay back his or her student loans? This is a very difficult standard to meet, and most debtors are left with their student loan debt even after bankruptcy.

Can Student Loan Debt Qualify You for Chapter 7 Bankruptcy?

If you cannot discharge your student loan debt during bankruptcy, can it at least help you qualify for Chapter 7 bankruptcy to discharge your remaining debts? While this question has not been answered in the Court of Appeals for the Ninth Circuit (the federal court that sets precedent for bankruptcy cases in California and nearby states), a case in the tenth circuit partially addresses the issue.

In Stewart v. United States Trustee, the United States Court of Appeals for the Tenth Circuit inferred that student loan debt may be considered “non-consumer” debt rather than consumer debt. This is important because, as in Stewart, a trustee may dismiss a debtor’s Chapter 7 bankruptcy petition under 11 U.S.C. § 707(b) if the petition was considered substantially abusive and the debts were primarily consumer debts.

Consumer debts are debts that are “incurred by an individual primarily for a personal, family or household purpose.” Individuals who file for Chapter 7 bankruptcy must meet the Chapter 7 means test (a financial threshold test) if their debts are primarily consumer debts. If, however, the debtor is able to show that more than 50 percent of the debts could be classified as business debts or other non-consumer debts, then he or she does not need to meet the Chapter 7 means test.

In Stewart, the court held that the debtor’s student loan debts were largely consumer debts because the debtor used them for “dual family and personal purposes.” However, the court also inferred that the student loans may have been considered non-consumer debts if the debtor was able to offer evidence that the debts went toward “tuition, books or other direct educational expenses.” 

In other words, it may be possible to file for Chapter 7 bankruptcy if you can show the court that your student loan debts, along with your other debts, are primarily non-consumer or business debts.

Evolving Area of Law

This is an evolving area of law that may play out differently depending on the bankruptcy judge presiding over your case. For this and many other reasons, it is important to speak with an experienced bankruptcy lawyer about the debt relief options available to you. Financial relief may be possible, even if your student loan debts are not dischargeable through bankruptcy.

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