Can Student Loans Be Discharged in Bankruptcy?

In re Mathieu, __ B.R. __ (Bankr. D. Minn. 2013) is a bankruptcy case out of Minnesota but we believe it has value for our New Jersey readers. The undue hardship standard for discharging student loans applies nationwide, and is a tough hurdle.

Student Loan Debt in Bankruptcy  

Many careers require a college education, but few people can afford the price tag. Student loans meet that need. Lenders offer student loans because people with a college education are much more likely to have the capacity to repay a loan than people without – college graduates earn 85% more than high school graduates on average. Despite that figure, a degree does not guarantee a particular income and some college graduates struggle to afford basic necessities. When low earnings combine with external circumstances, repayment of student loans may simply be impossible. While student loans are generally not dischargeable in bankruptcy, if repayment is truly impossible, the court may order a discharge.

A Case From Minnesota

Cynthia borrowed about $21,000 to finance her college degree. She graduated in 1992, and the next year, she and her husband purchased a dance studio and ran it together. In 1995, they had a son. He suffered from acute lymphocytic leukemia and required full-time care. In 1999, Cynthia and her husband divorced and she had to close the dance studio because she couldn’t both run it and care for her sick child. In re Mathieu, __ B.R. __ (Bankr. D. Minn. 2013).

Until 2007, Cynthia worked at low-paying jobs, making less than $10,000 annually. In 2008 she obtained a position at a tax software company and then in 2010 became a tax preparer, eventually earning just over $50,000 annually. However, the tax preparation company was struggling and Cynthia worried that her job was insecure. For extra cash, she waited tables from time to time at a local restaurant. Id.

The same year Cynthia and her husband divorced, her son fortunately entered long-term remission from his acute lymphocytic leukemia. While the leukemia was no longer a concern by the time Cynthia filed for bankruptcy, he had other problems. He suffered from ADHD and Asperger Syndrome, and at 17 years old he was incapable of passing a driving test or understanding a job application or interview. He took some classes in the special education department and some mainstream classes, but was still very much dependent. Id.

A Growing Concern

For twenty years after Cynthia graduated from college, she struggled to make ends meet. She could not make her monthly student loan payments and at different times enrolled in two loan rehabilitation programs. When the second one ended, her required payments topped $700 monthly. By 2012, the balance on her loan had grown to more than $140,000.

The Educational Credit Management Corporation, which held her loan, suggested two potential payment plans. Under the IBR, she would pay $339 monthly for twenty-five years. At the end of that time, the remaining balance, which would be $943,139, would be forgiven. Under the ICRP, she would pay $575 monthly for twenty-five years. At the end, her remaining outstanding balance of $678,554 would be forgiven. In twenty-five years, Cynthia would be 72 years old. She filed for chapter 7 bankruptcy and sought discharge of her student loans. Id.

Undue Hardship and Student Loans

The court considers three factors in determining whether student loan repayment is an undue hardship on the debtor: “1) the debtor’s past, present, and reasonably reliable future financial resources; 2) calculation of the debtor’s and debtor’s dependents’ reasonable and necessary living expenses; and 3) any other relevant facts and circumstances…” Id. at 4, quoting In re Long, 322 F.3d 549 (8th Cir. 2003).

Passing the Student Loan Test

Cynthia had a “modest income” when she filed for bankruptcy and was unlikely to earn more in the future. When her son turned 18, she would lose his child support income and would not be able to cover the gap by waitressing. Her expenses were reasonable and were likely to increase, given her son’s needs. The court found that she would suffer undue hardship if forced to repay the loans; she was already struggling to make ends meet and support her son and she wouldn’t be earning any more in the future. The court ordered the discharge of her student loans.

Student Loans Discharged

Cynthia faced a difficult series of events that left her a single mother of a child with special needs and serious health problems. She struggled for decades to support herself and her son and had nothing to spare to pay toward student loans. The only option her lender offered was twenty-five more years of indebtedness, during which she would be unable to replace her car or rent an apartment because of the damage to her credit. For her, repayment was impossible. Forcing her to make loan payments would have been an incredible hardship on both Cynthia and her son. Student loan discharge is a serious measure for serious situations; for Cynthia, repayment was truly impossible.