What Are The Conditions For Canceling A Student Loan In Bankruptcy?

One of the most pervasive myths in Chapter 7 bankruptcy law is that courts never discharge student loans. While there is a higher-clearing standard for the discharge of a student loan versus other types of debt, it may be possible. Let's look at what the standard is and what conditions might allow it.

Undue Hardship

In bankruptcy law, the standard for the discharge of a student loan is mostly centered on the notion of undue hardship. This means the financial hardship that would arise from leaving the repayment obligation in place is so powerful that the borrower would be hopeless to ever repay it. Generally, judges interpret this as meaning that repayment would be hopeless even after the discharge of other debts.

Notably, there is not a lot of settled law on this issue. No Supreme Court precedent has ever defined what an undue hardship is in the bankruptcy process or how all judges should apply the text to student loans. Also, there are at least three different tests used in different appeals courts because the standards have never been reconciled. Consequently, each U.S. Appeals Court district uses its own standard.

However, there are some commonalities. Particularly, the three standards agree that someone in poverty without any long-term prospects of getting out of it without the discharge of the student loan is experiencing undue hardship. Generally, the petitioner must also be in poverty through no fault of their own. The petitioner must have made a good-faith effort to negotiate more favorable terms, too.

It's also notable that the judge does not have to discharge the full amount, unlike other debts in Chapter 7 bankruptcy law. Instead, the court only has to reduce the amount owed and the interest rate to a point that removes the undue hardship.

By the Numbers

Each year, about 250,000 filers have potentially dischargeable student loan debts. Research on the topic indicates that the vast majority of petitioners with student loan debts do not attempt to have a court discharge them.

Something interest occurs when people do request discharges, though. Between 40 and 50 percent will encounter a judge who grants the request. The logical inference is that a lot more people should consider asking than do.

How to Do It

The process is similar to asking for the discharge of other debts by listing them in your petition. One big difference is that a judge will scrutinize the request because of the undue hardship test and how it relates to federal poverty guidelines and your future earning potential.