How the Student Loan Repayment Period Affects Dischargeability of the Loan in Bankruptcy

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Aug 03

It is very difficult to discharge student loans in bankruptcy. In fact, many of my clients believe it is impossible to discharge student loans.

Actually, student loans are sometimes dischargeable in bankruptcy, but requires proof of “undue hardship”.

To determine undue hardship, most courts around the country have adopted the test set forth in a 1987 case, Brunner v. NY HESC. Wisconsin is in the 7th Circuit, and is among those circuits which have adopted this test.

Under the Brunner test, debtor must establish by a preponderance of the evidence, all three of the following:

  1. An inability to maintain a minimal standard of living if the loan must be repaid.
  1. Additional circumstances showing that this inability will continue for a significant portion of the loan repayment period.
  1. A good-faith effort has been made to repay the loan.

 

These elements are difficult to prove in most cases, in part due to the fact that some courts, including the 7th Circuit, have required that the debtors’ situation be one of nearly utter hopelessness.

Courts around the country are slowly changing, and a recent decision out of Philadelphia has interpreted the second element in a way which may be beneficial to debtors.

In that case, a 29-year-old woman with three young children had more than $25,000 in student loans.  Those loans required $300 a month in payments. The debtor was educated, healthy, and licensed as a vascular sonographer.  Unfortunately, the job market for vascular sonographers was saturated, and although she could make $35 an hour, she could only find about 20 hours per week to work.  She could have obtained a second job, but the court found that her wages would not be sufficient from that second job to cover the higher child care expenses which would be incurred.

The government agreed that the first and third elements of the Brunner test were met.  The argument was over the second element.  The government argued that the repayment period to be considered by the Court should be the 25 years available under Department of Education repayment programs.  The remaining term of the loan was only seven years, which the debtor argued should be considered the repayment period for purposes of the test.

The question therefore became “how long must the debtor show an inability to repay the loan?”

The court found that looking far into the future is virtually impossible, which would force the court to simply guess about the debtor’s circumstances at that future time.  The court found that the repayment period to be used under the second prong of the test “is the remaining contractual term of the debtor’s loan.”

Since the second element of the test requires the debtor to show her poor financial circumstances are likely to continue for a “significant portion” of the repayment period, the court next had to determine what constituted a “significant portion”.

It found that in this instance, 5 years would be appropriate. This constituted about 70% of the remaining seven-year term of the loan.

The Philadelphia Bankruptcy Court in this case is located in the 3rd Circuit, and this decision is in no way binding upon any court in the 7th Circuit.

Still, it provides us with guidance and good arguments to use in trying to obtain a discharge of student loans. We will continue to keep you updated as this issue continues to evolve.