Discharging Student Loan Debt — Applicable Only to Government Loans?

8.25.11    By Griffin Dunham    Tags

I had lunch a few days ago with a fellow lawyer and he had some questions about discharging student loan debt in bankruptcy. He heard that only loans through government-sponsored programs were nondischargeable because free market private originators didn’t need protection — after all, they made the business decision to set an interest rate and agree to terms they found acceptable.

He had part of it right. Section 523(a)(8) of the Bankruptcy Code does, indeed, deem that student loans funded in whole or part by the government are excepted from discharge absent an “undue hardship.” But, if you keep reading in this section, it also excepts loans from nonprofit institutions and “any other educational loan that is a qualified educational loan, as defined in section 221(d)(1) of the Internal Revenue Code.” Unfortunately for individual debtors, section 221(d)(1) of the IRC is drafted to include any loans, to include private loans, that pay for tuition, fees, books, and other “costs of attendance.” Through section 523 of the Bankruptcy Code and section 221 of the IRC, Congress has determined that private loans are afforded the same basic exception to discharge as federally backed loans.

As mentioned above, student loans are excepted from discharge absent an undue hardship. This is really tough for a debtor to satisfy, but I thought it’d be worth providing the three-part test (known as the “Brunner Test”) used to determine if undue hardship has been proven:

1. that the debtor cannot maintain, based on current income and expenses, a “minimal” standard of living for [herself] and [her] dependents if forced to repay the loans;

2. 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; and

3. that the debtor has made good faith efforts to repay the loans.

See Brunner v. New York State Higher Educ. Serv. Corp., 831 F.2d 395 (2d Cir. 1987).

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