How Can I Include Student Loans in Bankruptcy?

Many students rely on government guaranteed student loans to pay for college.

The Founding Fathers considered the topic of bankruptcy to be of sufficient importance to invest the United States Congress with the sole right and obligation for creating bankruptcy law. All bankruptcy cases are federal cases and are heard in federal bankruptcy court. Bankruptcy provides relief to honest but unfortunate debtors who have no ability or resources to pay their debts. Not all debts may be discharged through bankruptcy. The Bankruptcy Code exempts most government-funded or guaranteed student loans from discharge.

Bankruptcy Code

Section 523(a)(8) of 11 United States Code, commonly referred to as the Bankruptcy Code, states that loans "made, insured, or guaranteed by a governmental unit" for educational purposes cannot be discharged through bankruptcy. This stipulation applies to loans made by any agency of the federal government or by any nonprofit institution that made such a loan under provisions of a government-funded program. Provisions of this paragraph also extend to any loan defined as an educational loan by the Internal Revenue Code of 1986. Most private and public student loans fall into one of these categories and are not dischargeable by bankruptcy.

Educational Loans

Any loan taken out for the sole purpose of paying expenses associated with the education of an eligible student is considered to be a nondischargeable educational loan, commonly referred to as a student loan. Nondischargeable student loans include loans taken out for the benefit of the student. The student may be the borrower, the dependent of the borrower or the spouse of the borrower.

Hardship

The court may still grant a discharge of student loans if the debtor can show that the repayment of the student loan will result in an "undue hardship" on the debtor or his dependents. The determination of what constitutes an undue hardship is not defined by the Bankruptcy Code and is left to the discretion of the federal bankruptcy judge who has jurisdiction over the case, but some courts use the Brunner test. This test requires the debtor to prove he has made a good faith effort to pay his student loan, that repayment of the loan will prevent him from maintaining a minimal standard of living and that his financial circumstances are not likely to significantly improve during the repayment period.

Dischargeable Loans

Loans used for educational purposes that do not meet the definition of an educational loan by either the Bankruptcy Code or the Internal Revenue Code may be discharged by bankruptcy. A signature loan taken from a financial services company that was not designated as a student loan is dischargeable, even if the proceeds of the loan were used for educational purposes. A student who used his credit cards to pay for educational expenses may have those debts discharged. Loans made to pay for education at a school that is not eligible to participate in Title IV programs may be discharged through bankruptcy.

References

• Student Loan Borrower Assistance: Student Loans & Bankruptcy
• Sallie Mae: Bankruptcy and Student Loans
• FinAid: Bankruptcy and Financial Aid

Resources

• Administrative Office of the U.S. Courts: Bankruptcy Basics (pdf)