The debtor's options with respect to discharging student loans in bankruptcy have shrunk to only a few. Changes to the Bankruptcy Code in late 1998 made student loans non-dischargeable notwithstanding the age of the loan, unless the borrower can establish a substantial undue hardship. To make matters worse, changes in 2005 made even private student loans non-dischargeable in bankruptcy cases.
Student Loans are no longer dischargeable in bankruptcy simply because they have been in pay status for a certain amount of time. The main way to eliminate a student loan is to make a showing that repayment of the loan will create an undue hardship for the debtor and his family. This is an extremely high standard and is generally interpreted to mean that the debtor cannot otherwise maintain an adequate standard of living in addition to repaying the loan and that these conditions are likely to remain constant over a substantial period of time. Some courts will allow the debtor to pay a portion of the loan and discharge the rest depending on the facts of the case. In order to attempt a hardship discharge of your student loans, an adversary proceeding must be filed in the underlying bankruptcy case.
This issue is typically raised in Chapter 13 cases where there is a dividend paid to unsecured creditors. Because there is no dividend paid to creditors in most chapter 7 cases, there is no reason for the bankruptcy court to rule on the enforceability of a student loan claim outside of an adversary proceeding to determine undue hardship. Also, because student loans are contracts, they are subject to challenge for fraud, school closure etc.
Because the vast majority of student loans are bought and sold by other creditors, a big problem is the accuracy of the amount actually owed. One tactic is to file an objection to the student loan creditor's proof of claim to get a judicial determination as to the actual amount owed. The burden is on the creditor and they must substantiate the amount they are owed in order to have an allowable claim in the bankruptcy case. While student loans generally cannot be discharged in bankruptcy, there is some comfort to borrowers in federal regulations that restrict the amount a borrowers wages can be garnished to 10% of the borrowers net pay (59 Fed. Reg. 22473).