We’ve Got Good News!
(Updated September, 2014)
I’ve got great news for those of you interested in seeking a private student loan discharge via filing for bankruptcy:
The Eighth Circuit Court of Appeals recently affirmed a decision make by its Bankruptcy Appellate Panel that opened the way for a borrower to receive discharges on 15 different private student loans and a combined total balance of over $118,000!
This is a landmark case that cuts against the grain of the logic typically used to determine whether or not bankruptcy should provide some relief from private student loan debt, and a case that could pave the way for you to get your loans forgiven by filing for bankruptcy.
For details on the case, please view our write-up at the bottom of this page, or click here.
Private Student Loans & Bankruptcy Law
The relationship between private student loans and bankruptcy has been muddled ever since the war on student loan debt began way back in the 70’s, but even in 2014, it’s still possible to get rid of private student loan debt by filing for bankruptcy.
This page will teach you how to figure out if you’re likely to get approval for having your private student loan debt discharged, which type of bankruptcy you should file (Chapter 7 vs. Chapter 13), and what you can expect to face during the legal proceedings.
Can You File Bankruptcy on Private Student Loans?
Yes, you absolutely can.
It’s a bit complicated, but not so difficult that you can’t figure it out with a little bit of research.
Many people think that filing bankruptcy on private student loans is no longer possible, but that’s simply not the case.
In 2014, you can absolutely file bankruptcy over private student loan debt, but better yet, you can get that debt entirely erased by having it “discharged”.
Winning a private student loan discharge does require going to court, and it will likely require the services of a lawyer, but it’s certainly possible to fight, and win, especially if you’re well prepared.
How Does Private Student Loan Bankruptcy Work?
During the bankruptcy process, you’ll need to issue a formal complaint arguing that your student loan debt is placing an “undue hardship” on your life, preventing you from being able to provide basic life needs for yourself and/or your dependents.
It’s tough to receive an undue hardship discharge for certain types of private students loans, but it’s exceptionally easy for others!
The difficulty is determined by the type of school you attended, the specific school where you received your education, and the type of educational program you borrowed money to attend.
Here are the types of private student loans that are typically easy to discharge via filing for bankruptcy:
- Private student loans to attend a school that is not on the Department of Education’s list of “eligible educational institutions” (explained below in the section called “Am I Likely to Receive Approval for Discharge?”)
- Private student loans that were provided by large, national lenders, like well-known banks or other massive financial institutions
- Private student loans that were issued for education that isn’t offered at traditional four year colleges and universities, such as technical training programs, vocational training programs, truck driving schools, IT training courses, coaching classes, mechanic schools, cooking schools and beauty schools
Keep in mind too that even if you don’t qualify for a full discharge, you may end up being eligible for having some percentage of your private student loan debt erased during bankruptcy proceedings.
The relationship between bankruptcy and private student loans is definitely complicated, but this article should help you figure out just how to take advantage of the available opportunities.
Discharging Private Student Loan Debt Via Bankruptcy
Getting your private student loans discharged during bankruptcy proceedings doesn’t happen automatically, as it’s not part of the basic bankruptcy process.
To receive a discharge for your debt, you’ll need to file a petition (called an “adversary proceeding”) that requests a court judgment (called a “determination”) on whether or not you will receive approval for having your private student loan debt discharged.
After filing the petition, you’ll have to prove to the court that paying off your loan “will impose an undue hardship on your and your dependents.”
The basic idea here is that the court has to agree that your loans are destroying your life by making it impossible for you to provide food, shelter and other basic needs for yourself and/or your family.
This isn’t an easy to thing to do, even if your loans really are causing you serious financial hardship, especially because different courts use different “tests” to determine whether or not you’re truly facing an “undue hardship”.
Which Undue Hardship Test Will You Face?
We can’t answer that question with any shred of accuracy, and to get an accurate answer, we’d recommend that you consult with a local bankruptcy attorney.
Courts in different parts of the country use different tests, but it appears to be up to the judge’s discretion (at least in some cases) on how this stuff is handled.
And to add to the confusion, some courts take the test as an all or nothing deal where you either qualify for having your entire loan discharged or fail to qualify for having any of it discharged, while others will allow you to discharge some portion of your loan depending on the results of the test.
However, to help give you an idea of what you’ll be facing when trying to get approval for an undue hardship discharge, here’s a breakdown of the most common undue hardship tests in use today:
The Brunner Test
The Brunner test for undue hardship allows you to discharge student loans in bankruptcy proceedings if, and only if, you meet all three of the following conditions:
- Poverty – If you are forced to repay your private student loans, your current income and expenses will not allow you to maintain a minimal standard of living for yourself and your dependents
- Persistence – Your current financial situation (really, the problems relating to it) is likely to remain consistent for a significant part of the remaining repayment schedule
- Good Faith – You have previously made a good faith effort to repay your private student loans by making spending changes
How do you satisfy these conditions?
You’re having trouble paying rent, keeping the lights on and putting food on the table, but you haven’t been taking annual family vacations, you aren’t driving new vehicles, you didn’t recently buy a house, your apartment isn’t furnished with high-quality electronics and you don’t have the latest iPhone in your pocket.
You actually need to live, and look like someone who is living at, near or below the poverty line. If you can’t afford to pay off your private student loans because you blew all the money for them on personal possessions, luxury expenses, or comic books, then you won’t be able to get the debt discharged in bankruptcy when the court applies the Brunner test.
The Johnson Test
The Johnson Test for undue hardship is pretty similar to the Brunner test in that it tries to assess whether or not your private student loan debt will destroy your ability to maintain a minimal standard of living, but it’s more comprehensive than the Brunner test.
This test evaluations the following factors:
- Employment & Income – This test will evluation your current employment and income, along with your future prospects, comparing them to the Federal poverty line to determine where you fall on the spectrum
- Education – Your level of education, the effect it has had on your ability to generate income, and the effect it will have on your ability to generate income in the future
- Health – Your ability to stay healthy and remain in the workforce. This part of the test is especially helpful to those with chronic diseases or life-threatening conditions likely to reduce their ability to continue earning an income
- Dependents – Essentially, your expenses. This test makes it easier for those with more dependents to have their private student loans discharged, since dependents are seen as a serious burden
- Good Faith Efforts – Your previous attempts to pay off the debt. This attempts to find out if your current financial situation was caused through irresponsible or negligent behavior by evaluating your attempts to maximizing income and minimize expenses
How do you satisfy these conditions?
Just like the Brunner test – you’d better look like you’ve tried to pay off your debt, minimize expenses and reduce the amount of money that you “wasted” on inessentials. If you’ve got a lot of cool stuff, took some vacations or remodeled your house, then you’re probably out of luck.
The Totality of Circumstances Test
In our opinion, this seems like the most fair test of the bunch, since it purports to consider situations on a case-by-case basis.
The Totality of Circumstances Test seems more likely to want to help you win approval for winning private student loan bankruptcy discharge.
This test seeks to evaluate whether or not you have the ability to repay your debt based on the following conditions:
- Your Past, Present & Future Financial Resources – How much money have you been making? How much are you making now, and what will you be making in the future? Will it be enough to provide for that minimal standard of living?
- Your Reasonable Living Expenses – Based on the number of dependents you have, what is a reasonable estimate for your actual living expenses? How much money do you really need to get by? And will the private student loan prevent you from doing that?
- The Duration of The Hardship – How much longer will you have to work to pay off the loan? Are you temporarily, or even permanently disabled? Do you even have enough time left in your life to work off this debt?
- Your Attempts to Pay It off – Have you sought out other available options for debt relief? Did you attempt a loan modification, refinance or consolidation? Have you borrowed money from other lenders to pay for this loan? Have you cut costs in non-essential expenses?
How do you satisfy these conditions?
Same way as the Brunner and Johnson test – you’d better look like you’ve tried to cut costs, limit your expenses, and paid off that private student loan, or you’re not going to win approval for having the debt discharged via bankruptcy.
The Bryant Poverty Test
This test is the simplest, and probably the hardest to qualify for, unless you’re really having trouble making payments and providing for your family.
Unlike the other tests, this is a pretty simple numbers-based approach to determining whether or not your loan leads you to face an undue hardship.
Here how it works:
- Is your after-tax net income near or below the federal poverty level?
How do you satisfy this condition?
You’d better not be making good money, no matter what your expenses are. Even if you’ve got 10 dependents and a ton of other debt, if you’re making enough money that you’re nowhere near the established federal poverty level, you’re not going to get approved for discharge here.
Which Type of Bankruptcy Should I File?
It’s important that you consult with a bankruptcy attorney on this point, because Chapter 7 and Chapter 13 bankruptcy’s work in very different ways.
You’ll face very different consequences from the two types of bankruptcy if your request for discharge gets denied, so choosing the right one can stand to save (or cost) you tens of thousands of dollars.
Here’s what happens if you fail to receive approval for having your debt discharged via the undue hardship tests:
- With Chapter 7 Bankruptcy – You won’t have any other options if you fail to receive approval for discharge. Once you’ve been denied discharge, you’ll still owe your lenders the full amount of your private student loan debt once the bankruptcy case has ended.
- With Chapter 13 Bankruptcy – You will have some other opportunities for financial assistance if you fail to receive approval for discharge.
Filing for Chapter 13 will give you a little more wiggle room if you don’t end up qualifying for private student loan discharge during your bankruptcy arbitration.
You should speak with a local bankruptcy attorney to find out which type of bankruptcy will be the best option for your specific financial situation.
Chapter 13 vs. Chapter 7
If it doesn’t seem likely that you’re going to be approved for a discharge via the undue hardship rule, then filing Chapter 13 is probably your best option for getting back on your financial feet, especially if it’s your private student loan debt that’s causing you so much financial trouble.
When you file bankruptcy under Chapter 13, you’re essentially agreeing to perform a debt “reorganization”, which restructures your debt (rather than completely erasing all of it), and allows you to pay it off in a way that prevents you from being forced into poverty.
Chapter 13 debt reorganization plans are a tool to buy you time to save up money so you can catch up on those bills that you can’t afford right now, whether it’s a late mortgage, overdue car loans or late payments on private student loan debt.
The best reason to file using Chapter 13 is that you’ll have better options for additional assistance if your request for discharge gets denied during bankruptcy proceedings, whereas with a Chapter 7 bankruptcy, you’ll still owe the full amount of your private student loan debt, and you won’t have any other opportunities to get it reduced.
Benefits to Filing Chapter 13 Bankruptcy
There are some significant reasons why you should consider filing bankruptcy under Chapter 13 if the main goal of your bankruptcy is to help tackle private student loan debt.
Here are the major benefits to filing bankruptcy via Chapter 13:
- Your Chapter 13 plan (the debt restructuring plan that you put together) will determine the size of your monthly student loan payments, rather than your lender, potentially saving you hundreds of dollars each month
- You’ll get to make payments at the level you’ve laid out in the Chapter 13 plan for 3-5 years, however long your reorganization plan is set up to run for, potentially saving you thousands of dollars in reduced student loan payments over that 3-5 year period of time
- You will still owe whatever’s left of your student loans after you come out of bankruptcy (at the end of the 3-5 yeras that your reorganization plan lasts for), but you can attempt to discharge what’s left of you private student loan debt again using the undue hardship rule
- You won’t have to face any collection actions while you’re making repayments under your Chapter 13 debt reorganization plan, so no collectors will be able to harass you for that period of 3 to 5 years
- You might be able to assign priority to your private student loan debt during the course of your Chapter 13 plan, allowing you to focus on paying off your student loans and ignore other debts for that period of 3 to 5 years
Only a local bankruptcy attorney can advise you on how this process will play out for your specific situation, and on whether you should choose to file under Chapter 13 or Chapter 7.
Raising Defenses in Bankruptcy Proceedings
Another tool in your arsenal – though you’ll need to consult with an attorney to figure out how to use it – is that you may be able to “raise a defense” in your case, claiming breach of contract, unfair or deceptive business practices, or fraud as defenses to continuing payments on your private student loans.
The way this works is that you have to convince the court that you’ve been swindled by agreeing to rack up huge student loan debt on the promise of future employment or financial gain that hasn’t been realized and isn’t likely to get realized in the future.
The key point is that the court will have to agree with you that your education credentials don’t live up to the hype that was promised, and that you’re in a worse situation now than you were in before you went to school.
Essentially, your argument is that yes, you did rack up a ton of debt, but no, it wasn’t created based on a legitimate reason, and so it should be cancelled since you were essentially scammed.
This strategy works best with vocational or trade schools, like trucking schools, culinary colleges, pilot training programs, or other educational programs that aren’t offered at traditional colleges and universities, and especially those from schools or other institutions with terrible job placement performance.
For some great examples of successful attempts to get debt discharged by raising defenses like these, check out Steve Rhode’s recent article here.
Am I Likely To Receive Approval for Discharge?
It’s hard to say, as it depends on your specific situation, the court your case will be tried in, and the judge who will preside over your case, but there’s one simple trick to quickly find out if the odds are in your favor.
Applicable bankruptcy laws state that “qualified education loans” from “eligible education institutions” cannot be discharged, and the Department of Education keeps a list of institutions that meet this criteria.
The way you can use this to your advantage is to check if your school is featured on that list. If your school is not on the list, then they’re technically not an “eligible education institution”, and you’ve got a much better chance of getting approval for your discharge request since your loan may not be counted as a “qualified education loan”.
To see if your school is on the list of eligible institutions, go here, and search for it. If your school doesn’t appear, you’ve got a pretty dang good chance of getting an approval for bankruptcy discharge, and you should definitely consult with a local bankruptcy attorney.
A Short History of Private Student Loans Bankruptcy Law
Before 1978, any student loan debt was dischargeable in bankruptcy, without any exceptions.
Whether your debt was from private student loans, or federally-funded loans, you could get rid of it in full, 100%, by filling for bankruptcy.
Banks and other powerful financial agencies (the lenders offering student loans) realized that this was a huge threat on their financial solvency, so they lobbied Congress to change the law, and started winning some serious concessions.
Here’s a short timeline on how the bankruptcy laws governing private student loan debt have changed since 1978:
- Pre-1978: All private student loan debt was eligible for discharge via bankruptcy, making it easy for people to discharge their student loan debt when they ran into serious trouble. This was great for those running into trouble, but bad for lenders.
- 1978: Lenders convinced Congress to pass a new law requiring that people pay their student loans for at least 5 years before they’re eligible to be discharged via filing for bankruptcy, unless loan repayments “represented undue hardship” to the borrower (making it difficult for them to pay for basic needs).
- 1979: Lenders lobbied successfully for a further tightening of the 5 year restriction, with the new law requiring that the 5 year repayment period couldn’t include any time that the student loan debt obligation was suspended, like during loan deferment or forebearance.
- 1990: Congress passes new restrictions requiring that borrowers pay off their student loans for at least 7 years before they’re eligible for discharge via bankruptcy, and with the same stipulation that none of those 7 years could include any period of time that the loan debt obligation was suspdended.
- 1998: Lenders land a huge win, convincing lawmakers to update the law so that private student loans aren’t dischargeable via bankruptcy ever, no matter how long the loan debt has been paid back. Even borrowers who had paid their loans off for 10, 15, or 20 years couldn’t discharge them via bankruptcy now.
- 2005: Previously, a loophole had allowed loans that were not made under a “program funded in whole or in part by a governmental unit or nonprofit institution” to be eligible for discharge, but a new law is passed to prevent virtually 100% of private student loans from qualifying for bankruptcy discharge.
What’s Different About the Conway Case?
Typically, bankruptcy courts rely on the precedent set by the 1987 case titled Brunner v. New York State Higher Education Services to decide whether or not private student loan debt can be discharged during bankruptcy proceedings.
The so-called “Brunner test” that emerged from this case requires that debtors prove three things in order to receive approval for having their debt discharged:
- That they cannot maintain a minimal standard of living for themselves, and their dependents, if forced to continue repaying their private student loan debt
- That their inability to repay the loan while maintaining a minimal standard of living is likely to persist throughout the remaining lifespan of the loan
- That they have made a “good faith effort” to repay the loan
These conditions have left a great deal of wiggle room for judges to rule that borrowers shouldn’t be eligible for bankruptcy discharges, using logic like:
- He may not be able to make the payments now because of unemployment or underemployment, but since he’s only 30, he’ll almost certainly be able to land another real job and start making payments again at some point in the future.
- She may be having trouble making payments now, but once her children turn 18 and start fending for themselves, she’ll have enough disposable income again to resume making her monthly private student loan payments each month.
Fortunately, the reality that Americans face an entirely different economy in the wake of the 2008 financial crisis has apparently taken root in the minds of some bankruptcy courts, including the Eight Circuit, and has lead to a new approach in bankruptcy rulings.
Does Conway Set A New Precedent?
In the case of Conway v. National Collegiate Trust, the Eight Circuit Court recently ruled that Ms. Conway should be granted permission to seek discharges of about 20 separate private student loans, loans with a combined total balance of well over $100,000 in total debt.
Conway graduated from a well-renowned school with a B.A. in Writing, and was able to find full-time work in the field, but was then laid off from two different jobs between her graduation and 2008.
As a response to her major economic troubles, she filed for bankruptcy protection, requesting to have her private student loans discharged in the process.
Two of her private lenders agreed, but a third company called the National Collegiate Trust (NCT), contested the initial court ruling.
At the time of the dispute, Ms. Conway had a total of 15 loans from NCT, which carried a total balance of $118,579.66 (including interest).
Conway’s Initial Ruling
At first, the bankruptcy court in Missouri agreed with the lender (NCT), and refused to allow the debt to be discharged, arguing that while Ms. Conway certainly couldn’t afford to pay off her loans now, she had a college degree, “well-developed writing and reasoning skills” and “at least 30 years left to navigate the job market” so she could resume making payments on her debt.
As mentioned above, this court used one of the arguments from the standard Brunner test to reject her request for discharge.
However, when Ms. Conway’s appeal reached the 8th Circuit’s Bankruptcy Appellate Panel (BAL), the lower court’s decision was overturned.
Here, the Court noted that if Ms. Conway were to make the minimum standard monthly payment of $846.17 on all 15 of her loans, there was no way she would be able to maintain a minimum standard of living.
In this case, the 8th Circuit ruled that each loan should be evaluated individually to determine whether or not they could be discharged.
This approach flies in the face of the gold-standard and more typical Brunner test, and instead uses the logic of the “Totality of the circumstances” test, which determines whether or not repayment would be deemed a hardship by using the debtor’s past, present and expected future finances.
In ruling that Ms. Conway deserved to have her debts discharged, the BAL used her current income as a server (rather than her future expected income as a professional writer) to calculate her monthly expenses, explaining that she clearly faced an undue hardship in this case.
This case paves the way for others in a similar situation as Ms. Conway to be evaluated for having their private student loans discharged via bankruptcy.
Especially interesting to me is the fact that the Eight Circuit wrote of their decision to use her actual wages rather than her anticipated future earnings, noting that they would “not substitute assumptions or speculation for reasonably reliable facts.”
While this decision can be seen as a major stepping stone in the nation-wide campaign against crushing private student loan debt, it should be noted that the precedent it sets is quite narrow in scope because:
- The ruling only applies to the Eighth Circuit, which includes North and South Dakotah, Minnesota, Nebraska, Iowa, Missouri and Arkansas
- The ruling is not yet a formal discharge order (meaning that Ms. Conway’s debt is not officially discharged yet), but instead an order for the lower bankruptcy court to evaluate each of her 15 student loans to determine their eligibility for discharge
However, it’s possible (and perhaps even likely) that this ruling could serve as a catalyst for a sea-change, opening up the potential for tens of thousands of other borrowers to have their private student loan debt discharged via bankruptcy, and saving many of this website’s visitors from a lifetime of debt slavery.
We’ll keep you updated as things progress in Ms. Conway’s case, so please be sure to check back soon for additional information.
For Additional Information
If you have other questions that weren’t answered here, please feel free to ask them in the comments section below.
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