What happens to student loan debt in bankruptcy? For the most part, it’s non-dischargeable unless the debtor can show that being required to repay the loan will cause an “undue hardship” on him. The term “undue hardship” is a term of art in bankruptcy and means that the debtor would be unable to provide the necessities of life for himself and his family. “Necessities” is a narrow term, and means things like food and shelter.
There are several reasons for the nondischargeability of student loans and the undue hardship test. The first is the feeling that if one takes advantage of the generous availability of student loans to gain an education, she should be expected to repay those debts. Another is that the various student loan programs have their own hardship discharge provisions and processes, some of which are easier to meet than the bankruptcy hardship discharge.
Student loan defaults are on the rise. As of the fourth quarter of 2018, according to this Bloomberg article, there was $166.4 billion in student loan delinquencies. This is more than 11% of the total $1.46 trillion student loan market. A 10% or more delinquency rate in any lending area is high and cause for concern.
There are some strategies for dealing with student loans in bankruptcy. One is the so-called “Chapter 20” where a debtor files a Chapter 7 (assuming she can qualify) to discharge that debt that can be discharged, followed by a Chapter 13 to deal with the student loans. While a Chapter 13 filed after a discharge in a Chapter 7 does not entitle the debtor to a second discharge (and the student loan debt isn’t dischargeable anyway), the Chapter 13 allows a framework within which the deb can be managed, at least temporarily. A second option is to try for the hardship discharge, which requires the debtor to file an adversary proceeding so the court can determine whether an undue hardship exists. These are successful only in the most extreme situations.
A third strategy which is just gaining some notoriety is to challenge the qualification of the loan as a student loan. A student loan is one that is an educational loan, which means a loan for “qualified educational expenses.” “Qualified educational expenses” are the costs of attendance at an institution of higher learning. Many student loans are used not only for tuition, books and other expenses of attendance, but are also for living expenses, such as rent, food, utilities and the like. Many graduate students rely on student loans to cover all their expenses, both living and the costs of schooling, while they are in their graduate programs. The strategy is to claim that to the extent a loan was used for living expenses and not for the costs of attending school, the loan is not an educational loan and is therefore dischargeable.
It’s still too early to tell whether this theory will gain widespread acceptance by bankruptcy courts. So far the information is anecdotal, but those reports are encouraging for discharge of at least some student loan debt.