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Student loans and Chapter 7 bankruptcy

Trying to achieve a fresh start is a common reason given by New Jersey residents for filing for bankruptcy. Student loan debt can pose financial challenges in a Chapter 7 or a Chapter 13 bankruptcy, because of special rules that make discharge of such debts extremely difficult. It might not be easy, but there are circumstances under which student loans might be eligible for discharge.

Student loans were once treated in the same manner as other unsecured consumer debt. Laws enacted by Congress to protect lenders established special rules for loans taken out to pay for college or trade school. Under the current law, education loans cannot be discharged in a consumer bankruptcy unless the individual can prove repayment of the debt creates an undue hardship. But a problem for the person seeking debt relief is the failure of Congress to define exactly what constitutes undue hardship.

Bankruptcy court judges have been left to decide for themselves on a case by case basis what undue hardship means in each case. A test used by many judges to decide if an undue hardship has been proven to exist in a particular case relies upon the consumer proving the existence of all three of the following criteria:

  • Continued payment of the student loan will prevent the individual from maintaining a minimum standard of living;
  • The consumer’s financial circumstances are not likely to improve in the future; and
  • There has been a good-faith effort by the borrower to repay the debt.

Evidence that proves all three of the criteria for discharge of student loans can be extremely difficult to obtain, but a consumer with financial challenges in addition to education loans still might benefit from filing for bankruptcy. The reduction or elimination of other debts that are dis-chargeable in a Chapter 7, or which are the subject of a repayment plan under a Chapter 13, might reduce a consumer's monthly debt enough to make repayment of student loans more manageable.

This post is not intended as a source of legal advice on the subject of discharging student loans. Anyone who needs information about bankruptcy and debt relief should seek out the advice of an attorney who practices in that area of the law.

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