When Did Student Loans Become Nondischargeable in Bankruptcy?

Federal student loans became nondischargeable in bankruptcy proceedings in 1976. Before then, debtors could discharge student loan debt along with most types of consumer debt.

That ended in 1976 when Congress amended the Higher Education Act of 1965.

In Section 439A of the Act, Congress made student loans nondischargeable in bankruptcy unless:

• More than five years have passed since you entered repayment or

• Not discharging the loans would cause you and your dependents an undue hardship.

Two years later, Congress passed the Bankruptcy Code. In the years since, Congress has retooled the law to further limit a debtor’s ability to file student loan bankruptcy.

But in all those changes, Congress never bothered to define undue hardship. As a result, bankruptcy judges have had to develop their own undue hardship standard tests. Depending on where you live, your judge will use the Brunner test or the totality of the circumstances test.

Related: Biden Approves $10k Debt Cancellation

Note: The Justice and Education Department announced a new path for student borrowers to discharge their college debt. The student loan bankruptcy reform is effective immediately. Lawmakers are still working on permanently reforming student loan bankruptcy rules.

You can file bankruptcy on student loans and get a fresh start — but it’s a challenge. Unlike other types of debt that go away automatically at the end of a bankruptcy case — e.g., medical bills, credit card debt, repossessions, and so on — you have to file a separate lawsuit to get rid of both federal and private student loans.

In the lawsuit, you’ll need to overcome decades of case law and convince a judge of one of two things. First, repaying your federal student loans will cause you an undue hardship. That’s hard to do because the Education Department offers affordable monthly payments with income-driven repayment plans and student loan forgiveness programs that wipe out your remaining balance if you work in public service, pay for 20+ years, or suffer a permanent disability.

Learn More: Can You File Bankruptcy on Student Loans?

Second, in the case of private student loans, you can avoid battling the undue hardship requirement if you can show that the loans you borrowed exceeded your school’s cost of attendance. Back in the mid-2000s, a lot of banks loaned money to students without checking if they had already received enough federal financial aid or scholarships to cover their tuition and living expenses. Those loans are now held by companies like National Collegiate Student Loan Trust, Navient, Citizens Bank, and so on.

Learn More: What Happens to Private Student Loans in Bankruptcy?

Student loans first became nondischargeable in bankruptcy in 1976 as part of § 439A Higher Education Act of 1976. Except in cases of undue hardship, Section 439A prohibited debtors from discharging student loan debt until five years after the start of the repayment period.

Why are student loans exempt from bankruptcy? Student loans are exempt from bankruptcy because many politicians feared that young people would borrow substantial sums to pay for college and then discharge their student loans in bankruptcy right after graduation. As a result, starting in the early 1970s, Congress began changing the bankruptcy laws to require a borrower to prove undue hardship before she could discharge her student loan debt.

Section 523(a)(8) of the U.S. Bankruptcy Code makes student loans exempt from discharge absent undue hardship.

Related: How 11 U.S.C. § 523(a)(8) Works

Specifically, 11 U.S.C. § 523(a)(8) says that education debt (a loan or educational benefit overpayment) is exempt from discharge in both Chapter 7 bankruptcy and Chapter 13 bankruptcy if:

1. It is a student loan made, guaranteed, or insured by the government

2. It is a student loan made under a loan program funded by the government

3. It is a student loan made under a loan program funded by a nonprofit

4. It is an educational benefit, scholarship, or stipend or

5. It meets the IRS’s criteria to be a qualified education loan

Are private student loans exempt from discharge? Private student loans are exempt from discharge in bankruptcy if they are a qualified education loan. A private loan is a qualified education loan if it did not exceed the student’s cost of attendance and the student attended a school eligible to participate in the Federal Student Aid Program.

Since it first made student loan debt nondischargeable in bankruptcy, Congress has changed the law 5 times:

1. The Act on August 14, 1979.

2. Bankruptcy Amendments and Federal Judgeship Act of 1984.

3. Crime Control Act of 1990.

4. Higher Education Amendments of 1998.

5. Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.

Here’s a slide deck showing the history of these amendments.

Related: Student Loan Bankruptcy Reform

The Commission on the Bankruptcy Laws of the United States recommended to Congress that educational debt be exempt from discharge in bankruptcy. The Commission made this recommendation despite evidence showing that less than 1% of federal student loans had been discharged in bankruptcy.

Congress passed the Higher Education Act of 1976 and included Section 439A, which made educational loans non-dischargeable for five years absent undue hardship.

Congress overhauled the Bankruptcy Code and added Section 523(a)(8). Under that section, education loans owed to a governmental unit or a nonprofit institution of higher education were nondischargeable for five years from the date the loan entered repayment unless the debtor was experiencing undue hardship.

The 1979 Act did two things. First, it made it so that a student loan made by the government or made under a government-funded program or a nonprofit institution was nondischargeable. This change made sure that a loan made under the Federal Perkins Loan program received discharge protection.

A Perkins Loan is a federal student loan made by a school to a student. The funds for the loan program come from a pool contributed to by both the government and the school.

Before the 1979 Act, it was arguable that a bankruptcy court could decide the section didn’t apply to a loan made under the Perkins loan program. This change closed that loophole.

Second, the Act also changed the Bankruptcy Code by extending the 5-year period when the student loan borrower took a deferment or forbearance.

This change made it more difficult to tell when five years had passed. No longer could you look at when the last loan entered repayment and add five years.

You had to pull the actual payment history for the student debt to see if there were any deferments or forbearances.

The 1984 Amendment removed the phrase “of higher education” from “nonprofit institution.” This change was made to include federal loans made by nonprofit institution centers that weren’t focused on higher education: seminaries, barbering colleges, etc.

In the late 1980s, Marie Brunner filed a bankruptcy case a few months after leaving college. The primary aim of her bankruptcy filing was to discharge the student loan debt she had just borrowed from the New York State Higher Education Services Corp.

The bankruptcy judge looked at Marie’s financial situation and allowed her to get rid of her student loans. NYSHE appealed to the district court. This is where the Brunner Test was born.

In reviewing the appeal, the district court judge looked at how other courts analyzed student loan dischargeability cases and created a three-part test to assess whether a debtor can discharge student loans in bankruptcy before the loans had been in repayment for five years:

1. The debtor cannot, based on current income and expenses, maintain a minimal standard of living for herself or her dependents if forced to repay the loans.

2. This state of affairs is likely to persist for a significant portion of the repayment period of the student loan.

3. The debtor has made good faith efforts to repay the loans.

After applying the test, the district court judge overturned the bankruptcy court judge’s decision. Marie appealed the decision, Brunner v. New York State Higher Education Services Corp., and lost.

The Crime Control Act changed the Bankruptcy Code in two ways.

First, it made conditional grants of money for education nondischargeable. Before this change, it was arguable that an ROTC scholarship recipient who didn’t fulfill his obligation could file bankruptcy and not have to pay his scholarship back. Following this change, a former ROTC cadet would have to prove undue hardship or wait until the repayment period lapsed before he could discharge his student loans.

Second, the Crime Act increased the waiting period to get a discharge of student loans from 5 years to 7 years.

With this amendment, Congress changed the way the section physically looked. Before the section was broke into two paragraphs, (A) and (B). After, there was just one.

Why this change was made, I don’t know. It saved space, I guess.

The change didn’t last long. Seven years later, Congress made its last change to the section.

In passing BAPCPA, Congress broke 523(a)(8) into three parts:

• § 523(a)(8)(A)(i)

• § 523(a)(8)(A)(ii) and

• § 523(a)(8)(B).

Bankruptcy judges and legal scholars have said that Congress broke the section into three parts to clarify that it was excepting three different types of education debts from discharge.

Under this subsection, a student loan is excepted from discharge if:

• it was made, insured, or guaranteed by the government, or

• it was made under any loan program funded in whole or in part by the government or nonprofit institution.

The first bullet point applies to student loans made or insured by the U.S. Department of Education and other government entities. For instance, this subsection applies to loans made under the Direct Loan Program and Federal Family Education Loan Program.

The second bullet point applies to loans made by nonprofit schools. For example, the Federal Perkins Loan Program and the school’s own student loan programs.

Over the years, private loan holders like National Collegiate Student Loan Trust have successfully argued their loans are protected under this subsection. Their argument has been that although the loans were made by a private lender, the loans were made under a program funded by a nonprofit entity, The Education Resources Institute (TERI).

That argument is flawed. TERI didn’t fund the loan program. It guaranteed loans made under loan programs funded by private lenders. Bankruptcy courts have ignored that difference.

This subsection protects an education debt if it is an obligation to repay funds received as an educational benefit, scholarship, or stipend.

For years, bankruptcy judges said that student loans were protected under this subsection because a debtor got an educational benefit from the loan.

Recently, bankruptcy courts have backed away from that reasoning.

Student loans are now exempt from this section, according to many bankruptcy courts. It instead applies to conditional monetary grants. That is, the section only applies to funds that must be repaid if a condition is not met. For example, if you are awarded an ROTC scholarship but do not complete your term of service, then the scholarship would become a debt that you would have to repay.

You can read more about this reasoning in the McDaniel v. Navient Solutions cas

In (B), Congress excepted private loans from discharge so long as the loans met the Internal Revenue Code’s requirements to be a “qualified education loan.”

Before this change, private student loans arguably weren’t protected from bankruptcy discharge. But, as I’ve shared above, Congress changed the bankruptcy law to protect federal student debt from discharge.

BAPCPA changed that — at least for loans made by private lenders that are qualified education loans.

The exact requirements for a loan to be a qualified education loan are many. We won’t go through them all here.

Instead, let’s focus on just two of the requirements:

1. The loan must be made to pay qualified higher-education expenses at a school participating in the federal student aid program and

2. The loan must not have exceeded the borrower’s cost of attendance.

Before I file an adversary proceeding for a private loan, I check both of these requirements. I’ve found focusing on those requirements to be the easiest way to determine if my client’s private student loan debt meets the criteria for protection or whether I have to argue undue hardship.

If your lender won’t give you an affordable repayment plan and you can no longer afford your student loan payments, the bankruptcy process can help.

You don’t need to hire a bankruptcy attorney to discharge your student loans. But hiring the right lawyer, especially a student loan lawyer, can help.

Let’s talk if you’re thinking about discharging your student loans in bankruptcy.

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