The excitement of receiving an offer from a person’s preferred college often overshadows the reality of figuring out how to pay for the degree, and many would certainly not think that going to college could lead them to contemplate bankruptcy. Since free higher education is not offered to Americans, like it is in Europe, absent a scholarship or parental contributions, students must find their own way to cover tuition and housing, which, for the majority, requires taking out student loans. Unfortunately, many students do not really understand the obligation they are choosing to assume and the associated long-term impact it will have on their finances after graduation.

With the cost of education increasing every year, it is not uncommon for students to come out with tens of thousands of dollars of debt, and entry level jobs rarely pay enough to cover even the minimum monthly payment. With crushing debt and no reasonable prospect of earning enough to repay the loans, considering bankruptcy could seem like an obvious choice, but loans taken out for educational purposes are not generally dischargeable in bankruptcy, which means even if bankruptcy wipes out other debts, like credit card balances and personal loans, student loans are still owed. A recent bankruptcy court decision, however, may give a glimmer of hope to graduate students who take out loans for prep courses for postgraduate exams. A brief outline of the court’s decision and the limited circumstances that will allow discharge in bankruptcy for student loans will follow below.

Bankruptcy Court Decision: Bar Prep Courses

A bankruptcy judge out of the Eastern District of New York, in a departure from other bankruptcy decisions on this issue, ruled that $15,000 bar study loan issued by Citibank to a student at Pace Law did not fall under the exception to the discharge of student loans because it did not qualify as an “educational benefit” under the bankruptcy code. The judge viewed the bar study loan as a standard commercial transaction that did not confer a benefit to the student, and noted that other courts who considered this issue seemed to conflate a loan with any connection to education as falling under the provision against discharge in bankruptcy. While this decision is not binding on other courts, it could be used as guidance on this issue in other cases and may mark the start of a shift away from courts automatically declaring a debt non-dischargeable because it relates in some way to education.

Exceptions to Prohibition on Discharge of Student Loans

As stated above, loans taken out by students to pay for higher education are not dischargeable in bankruptcy. The only exception to this rule is if the debtor can show an “undue hardship” would result if he/she is forced to repay the loans. The standard to show undue hardship for the discharge of student loans is very high, and few people are able to meet it. Most bankruptcy courts use a three-part test to determine if a person qualifies, with the first part examining whether the debtor made a good-faith effort to repay the loans, which means showing he/she tried to find a job and minimize expenses. Second, the court looks at a debtor’s budget to see if he/she can afford more than a minimal standard of living. Finally a judge must determine a person’s future prospects for repaying the loan debt. Essentially, a court must find the debtor has no hope of repaying the debt within the repayment period, which will always be a subjective, and therefore unpredictable, decision.

Talk to a Bankruptcy Lawyer

If you are feeling overwhelmed by debt and receiving multiple phone calls from collection agencies on a weekly basis, bankruptcy may be good option for you. Christopher L. Arrington represents clients in Chapter 7 bankruptcies in the Indianapolis area, and he can advise you if bankruptcy would alleviate your financial situation. Contact him to schedule a free consultation.