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When is a student loan really a student loan for bankruptcy purposes?

As most people who have invested in their education are already painfully aware, the ability to discharge student loans under the U.S. Bankruptcy Code is extremely difficult. That's because in order to eliminate this type of debt, it must be shown that the loan poses an "undue hardship" to the borrower.

In making this determination, the majority of bankruptcy courts will employ what is known as the "Brunner test," a three-prong examination that asks 1) whether the borrower is able to maintain a minimum standard of living while repaying the student loans, 2) whether the borrower has made repayment efforts and 3) whether the borrower's current financial issues are likely to continue.

While all of this may seem insurmountable, experts indicate that there may be options not otherwise obvious to financially distressed borrowers.

By way of example, they point to the question of whether some private student loans are classified incorrectly, such that the debt should avoid the above discussed process and actually be eligible for automatic discharge.

How exactly would this work?

Under the U.S. Bankruptcy Code, a "qualified education loan" must meet the definition as provided in the Internal Revenue Code.

Cross-referencing the applicable section of the IRS Code reveals that a "qualified education loan" is one from a "qualified educational institution." A list of qualified educational institutes, in turn, is published on a yearly basis by the Department of Education.

Accordingly, if an educational institution is not on the Department of Education's list, the underlying private debt could theoretically not be considered a student loan and, as such, eligible for automatic discharge.    

While this is an interesting idea, it's important to keep a few points in mind:

  • The Department of Education's list of qualified educational institutions is lengthy, such that there's a good chance an institution will be included and, as such, the debt classified as a student loan.
  • Not all bankruptcy courts have agreed with this idea, finding that this reclassification of private student loan debt is contrary to the intent of both the U.S. Bankruptcy Code and federal lawmakers.

More than anything, what all of this really serves to underscore is that those individuals facing serious financial difficulties -- including student loan debt -- should strongly consider speaking with an experienced legal professional who can examine their situation and help them explore all of their options -- including bankruptcy and alternatives.    

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