Treatment of Student Loans in Bankruptcy

Even though student loans fall in the category of unsecured debts, they are treated differently than other unsecured debts. This means that unlike other unsecured debts, student loans cannot be discharged through Chapter 7 bankruptcy (though there are some exceptions). However, if you file for a Chapter 13 bankruptcy, you will not have to pay the full loan amount through your repayment plan. This is due to the reason that student loans are non-priority unsecured debt. Therefore, unlike the priority unsecured debts, you are not required to pay them in full and they only receive pennies on the dollar. This partial amount that you pay depends on the your disposable income, the bankruptcy estate (created with your assets) available to the case trustee, and should be comparable to what the creditors would have got if you had rather filed for Chapter 7.

Before we go any further, let's discuss some of the terms used above. Unsecured debts refer to those debts that are not secured with a lien (collateral). Hence, creditors cannot claim your property (such as home, car, etc.) if you default. However, if not exempted by Federal or State law, you can still lose your property in Chapter 7 as case trustee could sell it to pay your creditors. Unsecured debts are further divided into two types: priority & non-priority debts. An unsecured priority debt gets paid before the non-priority type because it's assumed to be more important and under the Chapter 13 repayment plan they must be paid in full and not partially as in the case of non-priority debts.

Earlier we mentioned that there are some exceptions to the fact that student loans cannot be discharged in Chapter 7 bankruptcy. The discharge is possible in this case only if you can prove to the court that repaying the loan will put you through undue hardship. It is important to understand that proving undue hardship is extremely difficult due to the fact that not only you are required to prove that you can't repay it now but you also must prove that you would not be able to repay it in the future as well because it's unlikely that your financial condition will improve during the period of loan repayment. The commonly used test to determine undue hardship is known as the Brunner test.

In the Brunner test, there are three conditions that must be satisfied so that undue hardship can be confirmed and these conditions are:

1. If forced to repay the loan, the debtor and his/her dependent would fail to maintain the minimal standard of living, given the debtor's current income & expenditure.
2. It is difficult that the debtor's financial condition would significantly change during the course of the entire repayment plan.
3. That the debtor has made good faith effort to repay his/her loan.

If you’ve got questions about student loans, read the information here to learn more.

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