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Bankruptcy doesn’t mean student loans are canceled

Q. Thanks to thousands of dollars in federal student loans, my wife and I financed our college education in the 1990’s. We made payments for many years, but we suffered financial reverses in the economic downturn. Our largest debts are unpaid student loans. We’re thinking about filing for bankruptcy to wipe them out. We’ve received conflicting opinions. It sounds too good to be true. Is it legally allowed?

Doubtful debtors

If you had asked this question before October 1998 you would have been pleased to hear that the answer was yes. The federal bankruptcy law allowed student loans that had been in pay status for seven years to be eligible for a Chapter 7 discharge. But that loophole was closed, and student loans became non-dischargeable unless the borrower could prove undue hardship.

The undue hardship discharge in Section 523(a)(8) of the bankruptcy law is very hard to obtain. Applying debtors have the heavy burden of meeting all three of its strict legal requirements set forth in the case of Brunner v. NY State Higher Education Services., 831 F.2d 395 (2nd Cir. 1987).

“(1) that the debtor cannot maintain, based on current income and expenses, a ‘minimal’ standard of living for herself and her dependents if forced to repay the loans; and (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period for student loans; and (3) that the debtor has made good faith efforts to repay the loans.”

In the 2007 Florida case of In re: Cynthia Matthews-Hamad, No. 02-15746-8W7, the debtor failed to satisfy the Brunner test and was denied a hardship discharge for her $60,000 of student loan debt. The court analyzed how the case facts fit into the three legal tests of undue hardship, and ruled against her.

A. Minimal Standard of Living. Courts generally require more than temporary financial adversity, but typically stop short of utter hopelessness. Under this prong of the Brunner test, the debtor is not required to live in poverty, but she is also not entitled to maintain her previous standard of living.”

B. Additional Circumstances. The second prong is the heart of the Brunner test, and is often difficult to prove because it requires the debtor to show that she will be unable to pay her student loan debt in the future for reasons outside her control . . . Only a debtor with rare circumstances will satisfy this prong of Brunner.”

“C. Good Faith. This prong recognizes that with the receipt of a government-guaranteed education, the student assumes an obligation to make a good faith effort to repay those loans, as measured by his or her efforts to obtain employment, maximize income, and minimize expense.”

Social security benefits are chargeable for student loans

Q: My business career was financed by large student loans. I thought they were all paid in full. So imagine my surprise when I was informed by the government that one large student loan was long overdue, and they would now start deducting payments from my recently granted Social Security benefits. Can they do this?

Surprised Citizen

Unfortunately for you, the U.S. Supreme Court unanimously decided in December 2005 that the government can seize Social Security benefits to pay off old student loans. In Lockhart v. U.S.(546 U.S.(04-881) 2005), the plaintiff was a 67-year old retiree unemployed since 1981 and disabled after severe health problems. He lived solely on his monthly Social Security benefits. He had $80,000 of unpaid student loans used to attend various colleges back in the 1980s.

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