Are Student Loans Consumer Debt? It Depends

Both federal and private student loans are consumer debt like credit card debt, auto loans, mortgage debt, and payday loans. But what does that mean?

When you take out student loans or use your credit card to buy groceries, it’s assumed that you’re buying something for personal use. Unless you’re running a sandwich shop, you’re not buying bread for business purposes. You’re buying it to nourish yourself and your family.

But if you use debt to support your business, that would be considered a non-consumer or business debt.

Why does this distinction matter? It’s not particularly relevant unless you find yourself in a bankruptcy scenario. There, the distinction can mean the difference between qualifying for a Chapter 7 or Chapter 13 bankruptcy.

When it comes to bankruptcy, the law defines consumer debt as “debt incurred by an individual primarily for a personal, family, or household purpose.” Simple enough, right? But determining whether a particular debt qualifies as consumer debt isn’t always clear-cut.

Courts weigh several factors to make this determination, including the primary purpose for which the debt was incurred.

Generally, consumer debt is incurred voluntarily for personal or household purposes, results from consumption rather than earning money, and involves the extension of credit. And anything that’s not a consumer debt is a nonconsumer debt. This typically includes tax debt, business loans, and other debts used for investments in running a business.

But not all types of debt are assessed using the same criteria. For example, medical debt is evaluated differently than student loans, which are subject to a profit-motive test, i.e., did the debtor have a profit motive when borrowing the student debt?

Nearly twenty years ago, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act, which made it more challenging for Americans to wipe out their debts through Chapter 7 bankruptcies.

To qualify for Chapter 7 now, debtors must pass a means test that considers their income, expenses, and family size to determine whether they have enough disposable income to repay their debts. While the test aims to limit the number of debtors who can have their debts forgiven through Chapter 7, most people who take the test pass it easily.

Those who don’t pass the test must choose Chapter 13 instead. This type of bankruptcy sets up a repayment plan that lasts up to five years, making it more difficult for debtors to start over.

The disparity between the two types of bankruptcy in terms of speed and cost is significant. Chapter 7 takes only a few months, and most debtors need not pay anything back to their creditors. In contrast, Chapter 13 can last up to five years, and debtors must make monthly payments to the bankruptcy court the entire time.

But the means test only applies to those with primarily consumer debts, as opposed to business debts, per § 707 of the Bankruptcy Code.

Congress didn’t define what “primarily” means, but most courts have determined that it’s more than half.

That is to say, if more than half of the debtor’s debts are non-consumer or business debts, they’re eligible to file for Chapter 7 without taking the means test, and the presumption of abuse doesn’t apply.

The means test can be a real headache for those with high levels of student loan debt. This is because student loans are often classified as consumer debt, which makes it tough for high-earning borrowers to qualify for Chapter 7 bankruptcy.

But is it fair to lump all student loan debt in with consumer debt? After all, many people take out student loans to invest in professional degrees that can significantly increase their earning potential. It’s not as if they’re using that money to buy a new car or go on vacation.

That’s where I come in. I’ve worked with many high-earning student loan borrowers to help them sidestep the means test and qualify for Chapter 7 bankruptcy. We’ve secured Chapter 7 relief for many clients by arguing that their loans are nonconsumer debts.

From there, we can file a student loan adversary proceeding to try and discharge some or all of their education loans. It’s not always an easy road, but it’s a viable option for those dealing almost exclusively with student loan debt and wanting to avoid Chapter 13 bankruptcy.

When it comes to student loans, no court has declared them as per se consumer debts. While at least one bankruptcy court suggested that “student loans, in general, should be treated as ‘consumer debt,’” two federal appeals courts in Colorado declined to adopt a per se rule, leaving the matter unresolved.

So, how does one classify student loan debts?

They’re a unique type of debt that doesn’t fit neatly into the definition of “consumer debt.” Other courts have relied on the “profit motive” test to determine the primary purpose of a debt.

The case law suggests that distinguishing whether a student loan is a consumer or nonconsumer debt involves two inquiries.

The first inquiry is how the debtor used the loan proceeds. If the loan was used to cover living expenses while pursuing a degree, then it’s considered a consumer debt.

The second inquiry is whether the debtor had a “profit motive” when the debt was incurred. This motive is determined by the debtor’s situation when the loan was taken out. If the debtor wanted an education to increase their earning potential, then they had a profit motive, even if they intended to stay with their current employer or find a new position elsewhere.

Note: The “student loans are nonconsumer debt” is a technical legal argument that can be tricky for many bankruptcy lawyers to grasp — especially if they don’t have significant experience helping student loan borrowers. If you encounter pushback or difficulty, consulting with a student loan bankruptcy lawyer may be worthwhile.

Here’s a letter I sent to the US Trustee on behalf of one of my clients that I successfully squeezed into a Chapter 7.

And for those seeking a better understanding of the case law and policies surrounding the categorization of student loans as either consumer or nonconsumer debt, I recommend reviewing these cases and resources.

These can serve as valuable references to support your argument and strengthen your position in bankruptcy proceedings.

• Townson v. Ruff (In re Ruff), No. 20-68555-PWB, at *27 (Bankr. N.D. Ga. Mar. 31, 2022) (“[Th]e Debtor’s debts are not “primarily consumer debts,” and the “means test” provisions of 11 U.S.C. § 707(b) do not apply in her case.”).

• In re Ferreira, 549 B.R. 232, 240 (Bankr. E.D. Cal. 2016) (“[T]he debtor has not carried her burden of demonstrating that her student loans were incurred for a profit motive.”).

• In re Valdivia, No. 20-00369-5-DMW, at *10 (Bankr. E.D.N.C. Aug. 21, 2020) (“Congress did not define ‘consumer debt’ as a ‘debt incurred by an individual having no profit motive,’ but rather as a ‘debt incurred by an individual for a personal, family or household purpose.’).

• Punishing Our Professionals: Why Student Loans Should be Non-Consumer Debt, by Matthew Johnson.

Student loan debt is the lone wolf of consumer debt, growing steadily while other types have stagnated since the 2008 financial crisis, according to the Federal Reserve Bank of New York. Yet, during the pandemic, private lenders such as Sallie Mae, SoFi, and Discover, have continued to tack on interest to the loan balances of their borrowers, while the U.S. Department of Education has put a halt to student loan payments and interest rates for its borrowers.

This discrepancy in the treatment of student loan borrowers has only been magnified by the Biden administration’s recent changes to how it handles student loan bankruptcy cases and debt relief and loan forgiveness programs, which aim to eliminate billions of dollars in federal loans. The moves have sparked controversy and ignited a debate about the most effective approach to tackle America’s student loan debt crisis.

If you’re struggling with student loan debt and considering filing for bankruptcy but worried about being ineligible due to the means test, contact your bankruptcy lawyer to discuss the possibility of arguing that your loans are nonconsumer debts. Or, for further help, don’t hesitate to contact me.