Before you can get rid of your student loan in a Chapter 7 bankruptcy, you must establish that you suffer an “undue hardship.” In other words, you must show that your financial situation is so dire that it wouldn’t be fair to force you to pay your student loan back.
Qualifying for the undue hardship exception isn’t easy. Among the difficulties is that you must present proof at trial that you’re unable to make your payments now and will be unable to make them in the future.
The bankruptcy court wipes out student loans only in extraordinary cases. In most courts, you must pass a three-factor undue hardship test by proving the following:
Here’s how courts apply each of these elements.
The court will not discharge your student loan if your financial situation allows you to enjoy more than a minimal standard of living. In other words, while you’re allowed to support yourself and your family, your lifestyle must be extremely frugal and only provide for the necessities of life. For example, costs associated with new sneakers, knitting group classes, or even living in a safe, but higher-priced area, would likely count as unnecessary extras and thwart your discharge.
Also, the court includes the income of each member of your household when determining whether your income exceeds that needed to maintain a minimal standard of living. So if you make more than what’s necessary for basic needs after taking into account your teenager’s part-time job and grandma’s pension, you’ll likely lose.
Sometimes—especially during a recession—it’s hard to find work. But as the economy changes, opportunities improve. Ultimately, it’s up to you to prove that your current financial difficulties will stay the same going forward—at least throughout your loan repayment period.
Understand that the undue hardship exception exists to protect people suffering from extreme life difficulties, such as being rendered quadriplegic in a tragic accident. While courts frequently grant requests from the permanently disabled, they’re less sympathetic toward people who have made bad educational decisions. For example, the chances wouldn’t be nearly as good for a baker who overspent on a culinary program only to find out that the vast majority of available jobs pay minimum wage. The baker wouldn’t automatically lose, however. Courts consider requests on a case-by-case basis.
You also must show that you’ve tried to repay your obligation. Making payments for a reasonable period of time, like five years, usually meets this requirement. Consistently deferring your payments, however, might not. (Note, though, that some courts don’t require payments to meet the good-faith-effort requirement.)
You might be tempted to limit your income by quitting your job or divorcing your working spouse in order to meet the undue hardship test. Don’t do it. Your scheme will likely be seen as a transparent attempt to mislead the court. Depending on the severity of the offense, intentionally misleading a bankruptcy court can be prosecuted as either civil or criminal fraud. And the possible consequences—a denied discharge, fines, or jail time—aren’t worth it.
You start the bankruptcy process by filing your Chapter 7 bankruptcy petition. However, doing so is not enough for the court to decide whether your student loan should be discharged. In fact, if that’s all you do, nothing will happen. Student loans don’t go away unless you do more.
Before the court will consider discharging your student loan, you must take the additional step of filing an “adversary proceeding,” which is just another name for a lawsuit. You—or your attorney—will have to serve it on the holder of your student loan. Eventually, you and your student loan holder will both present evidence at trial, and the court will decide the outcome.
While the undue hardship threshold is hard to meet—for instance, you might have to hire an expensive expert to testify about your future employment outlook—it isn’t impossible. Courts have demonstrated a growing willingness to grant such discharges. Either way, different courts tend to take different positions, so it’s important to talk with a local attorney about your particular case.
While most people with student loan debt won’t be able to meet the undue hardship test, many still need help with overwhelming monthly payments. If you fall into this category, bankruptcy provides another option—filing for Chapter 13 bankruptcy can reduce student loan payments to a more manageable level for a three to five-year period.
For more information, see Can Chapter 13 Bankruptcy Help Me Lower My Student Loan Payment?
