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Student loans may be discharged in bankruptcy due to "undue hardship"

Under the Bankruptcy Code, student loans are dischargeable in bankruptcy if the failure to discharge the loans would cause undue hardship to the debtor and his or her dependents. However, the applicable statute does not define "undue hardship," meaning that courts must develop tests to determine whether undue hardship applies.

A recent United States Bankruptcy Court case from the Eastern District of Pennsylvania, In re Jones, provides an example.

Single mother with two children

The debtor filed a petition under Chapter 7 of the Bankruptcy Code and sought a discharge of two student loan obligations. To discharge student loans a debtor must prove: (1) that he or she cannot maintain a minimal standard of living, if forced to repay the loan; (2) additional circumstances exist indicating the situation is likely to persist for a significant portion of the repayment period; and (3) the debtor has made a good-faith effort to repay the loans. Generally, this is an extremely high hurdle to clear.

The debtor was a 45-year-old single woman who never received a high school diploma and had two daughters, the younger of which lived with the debtor and had been diagnosed with Attention Deficit Hyperactivity Disorder. The child's condition was severe enough that she had qualified for Social Security Disability benefits. The debtor could not leave her daughter alone, even at the age of 16, because she believed her daughter would be a risk to herself or the home. The debtor worked only part-time so that she could care for her child. The debts in question in the case were two student loans supporting her elder daughter's college education. The debtor had co-signed one student loan and signed alone for another.

Could the mother qualify for relief from the debts?

In reviewing the debtor's finances and situation, the court was satisfied that she could not maintain a minimal standard of living if required to make any repayment of the student loans. The debtor had no excessive or luxury expenses and the few expenses that one might question were offset by her likely under-budgeting for other basic expenses.

The debtor also met the second prong of the qualifying test, showing that her earning potential would not improve in the future. She was a single mother caring for a daughter with special needs, and her limited education foreclosed many employment opportunities. In addition, her younger daughter's childcare demands restricted the number of hours she could work.

Finally, the debtor established that she made a good-faith effort to repay her loans. Given the debtor's circumstances, the fact that she made no voluntary payments was understandable. Nothing in the record suggested that she was ever in the financial position to do so while maintaining a minimal standard of living. The debtor also testified that, as to the first loan, she believed she was under no obligation to pay until her daughter completed school, and she did not even understand that she was obligated on the second loan until her paycheck was garnished.

Considering all the evidence, the court concluded that the debtor had established that her student loans were dischargeable debts under the law.

The possibility of a fresh start

If you are faced with overwhelming debt, Chapter 7 bankruptcy may provide you with a fresh start. To determine if you qualify for Chapter 7, you will need to complete what is called a "means test." If you are considering a Chapter 7 bankruptcy, seek an experienced attorney who will be with you through every step, from the means test to completion of your case.

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