11 USC § 523(a)(8) — What it Means for Student Loans

Section 523(a)(8) of the Bankruptcy Code says that student loans and other educational debts won’t be discharged unless the debtor proves repayment would impose an undue hardship on them and their dependents.

Bankruptcy gives hundreds of thousands of Americans a fresh start every year. Bills for credit cards, medical expenses, and personal loans can be wiped away with a few strokes of a judge’s pen. But some debts aren’t as easy to erase.

Student loans will continue to haunt you after your bankruptcy case ends. Over the last four decades, Congress has tightened the bankruptcy law that governs the dischargeability of student loan debt — Section 523(a)(8) of the Bankruptcy Code — and courts have interpreted those changes differently.

The result: getting a discharge can depend on where you live.

Section 523(a) starts by saying, “A discharge under [Chapter 7, 11, or 13 bankruptcy] does not discharge an individual debtor from any debt…”

It then jumps down to subsection (8), which says that “unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for—

• (A)(i) an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

• (A)(ii) an obligation to repay funds received as an educational benefit, scholarship, or stipend; or

• (B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.”

Here’s what that means in plain English:

Bankruptcy law presumes* that certain debts owed for federal and private student loans, grants, and scholarships, can’t be discharged unless repayment would impose an undue hardship on the debtor and their dependents.

Learn More: Why Can’t You File Bankruptcy on Student Loans?

* Section 523(a)(8) is self-executing, which means that the creditor doesn’t have to take action in order for your student loan debts to be considered nondischargeable.

Not every debt that calls itself a student loan is a student loan for the purposes of 11 USC § 523(a)(8). Under that section, a loan is a student loan if:

• it was made, insured, or guaranteed by a governmental unit;

• it was made under a program funded by a governmental unit or a nonprofit institution; or

• it was made as a qualified education loan.

The first two bullet points concern loans made under the Federal Student Aid Program. The FSA program administers three loan programs:

1. the Direct Loan Program,

2. the Federal Family Education Loan Program, and

3. the Perkins Loan Program.

The final bullet point, which refers to qualified education loans, is about loans made by commercial lenders who are not part of the FSA program. A loan made by a for-profit, commercial entity outside of any government loan program is a qualified education loan under 523(a)(8)(B) if, among other things, it does not exceed the student’s cost of attendance.

Related: Can Private Student Loan Be Discharged in Bankruptcy?

The Bankruptcy Code doesn’t define the undue hardship standard, so courts developed their own definitions and tests to measure it. Some courts use the totality of the circumstances test, which forces judges to consider the “debtor’s past, present, and reasonably reliable future financial resources, [their] reasonable and necessary living expenses, and any other relevant facts and circumstances.”*

Related: How to Prove Undue Hardship for Student Loans

Most other courts in the country use a stricter test, named after a woman who raced to bankruptcy court less than a year after she completed a master’s degree. The Brunner Test has three prongs or questions the court asks when considering your hardship:

• Based on your current monthly income and expenses, can you repay your student loans and maintain a minimal standard of living?

• Is your financial situation likely to persist for a significant part of the repayment period?

• Have you made a good-faith effort to repay the loans?

* Educational Credit Mgmt. v. Jesperson, 571 F.3d 775, 779 (8th Cir. 2009).

Last week, the Justice Department and Education Department partnered together to release new guidance the government will use when defending student loan adversary proceedings.

Related: Student Loan Bankruptcy Reform

The new policy largely follows the Brunner Test, but it leaves more room for the Justice Department’s attorney to recommend the court grant an undue hardship discharge. For example, if your monthly expenses exceed your income and you’re at least 65 years old, have been in repayment for 10 years or more, or are disabled, the attorney may suggest that you’ve met the criteria for discharge.

Learn More: Student Loan Bankruptcy Guidelines

Section 523(a) lays out debts that politicians have determined are nondischargeable, meaning they won’t be eliminated when the bankruptcy court signs the discharge order at the end of the case.

This exceptional rule is reserved chiefly for extraordinary debts involving people who did bad things. Here are a few nondischargeable debts:

• Money and credit obtained by a false pretense, false representation, false statement, or actual fraud.

• Debt incurred due to larceny, fraud, or defalcation while working for a bank or credit union.

• Debt owed as restitution for a willful and malicious injury to another person.

It also includes money owed for certain cash advances, luxury goods and services, income taxes, and domestic support obligations.

Student loan debt isn’t like any of these debts, but it’s given the same harsh and dramatic treatment.

Why is that? The best reason I’ve found comes from a 2007 law review article, The Nondischargeability of Student Loans in Personal Bankruptcy Proceedings: The Search for a Theory. Professor John A.E. Potow concludes in the paper that the most compelling theory is that Congress wants to prevent opportunistic debtors from defrauding the system by borrowing federal loans they never intend to repay in order to fund their future high-income careers.

But why are private student loans also nondischargeable? It could be argued that exempting private loans from discharge would reduce the cost of borrowing loans for students. That argument is weak because it’s rare for borrowers to rush to bankruptcy court shortly after borrowing them to try and get rid of their loans. Most people struggle to repay their loans for years before they file bankruptcy paperwork.

UP NEXT: Can You File Bankruptcy on Student Loans