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Can Student Loans Be Discharged in Bankruptcy?

Finally — college graduation day after four long years of hard work and study. The promise of a well-paying career, instead of just a job, propelled you to make the commitment. But—you can’t find a job in your field thanks to the terrible economy—and you’re working behind the counter of the local Subway for minimum wage just to keep food in your belly.

The pressure is on because the $50,000 you took out in student loans from a bank are due now that you’ve graduated. There’s no way in hell you can make those monthly payments in your situation. Can bankruptcy be the solution?

Short answer: “No!” Years ago government student loans could not be discharged—or written off—in bankruptcy. But such loans were offered at very low interest, under 5%, and monthly payments generally were manageable. Since the advent of this grievous recession, far fewer of these government student loans have been available.

So to get their piece of the American Dream, college students turned to private lenders, banks and other institutions, to finance their educations. The kicker is, such loans are at much higher interest rates than government loans and often are variable rates that can rise precipitously.

Not only that, but many shady academic institutions often charge predatory interest rates as high as 18%. Students may be shown gaudy rates of job placement that are over-inflated and undocumented. When they graduate reality hits—they cannot find jobs and owe large monthly loan payments they cannot possibly make.

Is Bankruptcy the Solution?

Sadly, bankruptcy is generally not the answer. Changes to the Bankruptcy Code in 2005 make private student loans from lending institutions no longer dischargeable. Extreme conditions of privation or disability have to be met.

Bankruptcy courts relay on the three-part Brunner test to determine if extreme hardship allows a student loan to be discharged in bankruptcy. It’s based on a 30-year-old U.S. Court of Appeals decision. The three criteria to be met are:

  • The debtor cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and dependents if forced to pay off student loans;
  • that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans;
  • that the debtor has made good faith efforts to repay the loans.

At first impulse, it would seem that being unemployed, or vastly underemployed, would allow a freshly minted college graduate to meet these criteria. But not so fast—court interpretations have been beyond stringent in interpreting these three elements and especially in determining what constitutes “undue hardship.”

In a nutshell, even living below the poverty level has not been considered an adequate reason to discharge any student loan debt in bankruptcy. Even in cases of total disability courts have placed incredibly stringent requirements.

In one recent case, regarding a young man named Wallace, an Ohio bankruptcy court ruled that his total disability wasn’t really “total.” The guy graduated from college, got a managerial job in information technology and the future looked promising. However, after a year complications from diabetes affected his vision to the point of blindness. Then he developed kidney disease, resulting in continuous dialysis and numerous surgeries for kidney transplants. The Social Security Administration declared him permanently disabled.

Absurdly, in 2006 the bankruptcy court ruled that Wallace didn’t meet one of the three criteria of the Brunner case: he wasn’t suffering from undue hardship!

See documentary: Documentary on Student Loans

Decisions like this do not bode well for college graduates who cannot find work in this tanked economy.