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As the national student loan debt has soared—reaching $1.8 trillion, held by 43 million Americans, in 2023—the issue of declaring bankruptcy because of a student loan burden has taken on some urgency. The short answer is yes, you can file bankruptcy for student loans. But will such a filing succeed? That is the more pressing question. Up to now, the answer was: You would be unlikely to succeed if student loans were the main reason for your bankruptcy. And in fact, some petitioners for bankruptcy have found that they managed to get their debts discharged–except for their student loan obligations.Some would say that relief is needed. The average federal student loan debt balance reached $37,787 in 2023 while the total average balance (including private loan debt) may be as high as $40,780. When it comes to bankruptcy, the largest debts are most relevant. According to the Federal Reserve, more than 600,000 borrowers in the country are over $200,000 in student debt. Carrying a lot of student loan debt has created barriers to buying a house or realizing other dreams people have for their lives. Does bankruptcy offer a way out?No, for the most part. Legal observers have said there is a high degree of difficulty in discharging student loans through bankruptcy. The majority of student loans are federal student loans, and the government offers programs to adjust loan payments to a small percentage of someone’s earnings. To the court, this seems doable for most people.At this point, people rarely even try to file bankruptcy student loans. A study found that only 0.1 percent of debtors who have filed for bankruptcy attempt to discharge their student loans. However, change is at hand. The difficulty in student loan bankruptcy could be easing, according to policy changes announced by the Justice Department in November 2022 intended to make the process fairer, more transparent, and easier to get through.Read on to learn more about this crisis–and whether the changes could affect you.
What Kind of Bankruptcy Is Used for Federal Student Loans?
There is no special type of bankruptcy set aside for student loans.People file for bankruptcy through the federal court system. If you are successful, you receive aid in discharging your debts or making a plan to repay them. Individuals, couples, corporations, and small businesses can file for bankruptcy. There are three forms of bankruptcy: Chapter 7, Chapter 11, and Chapter 13.
Chapter 7 Bankruptcy
This is the most common form. It involves the selling or “liquidating” of an individual or business’s assets to distribute to creditors. Certain assets are exempt from this sale, such as cars needed for transportation, basic household furnishings, and the tools needed for work. Once these assets are liquidated and the debtor has given what money they can to their creditors, the rest of their debt is discharged. However, there are some things that don’t get liquidated. Typically, you would still be on the hook for child support, court-ordered alimony, taxes, and student loans. This form of bankruptcy doesn’t get rid of student loans automatically. You will need to file an adversary proceeding (AP) to have your student loans considered for discharge. Essentially, you must prove that repayment of the loan would cause undue hardship and you lack the ability to make any payments.
Chapter 11
This is the most complex form of bankruptcy. Chapter 11 bankruptcy helps struggling businesses restructure their finances so they can remain open. A debtor is able to remain in control of their business and renegotiate the terms of their debts with creditors, such as modifying interest, payment due dates, and other terms.Student loans rarely enter into a Chapter 11.
Chapter 13
Chapter 13 is called “adjustment of debts of an individual with regular income,” It’s also known as a reorganization.Chapter 13 means creating a repayment plan that uses up to 100% of a debtor’s disposable income to repay creditors within a certain time period. Repayment is supervised by the trustee, who collects from the debtor and redistributes it to the creditors as outlined in the repayment plan.Student loan discharge could be part of the disorganization, but only if you had filed an additional adversary proceeding and were able to prove you couldn’t make payments.
Bankruptcy and Federal Student Loan Debt?
Job loss is the leading reason for bankruptcy filings. When the court grants a bankruptcy, it’s typically because a person's lost employment combined with large medical expenses or unsustainable mortgage payments. Credit card debt is often in the mix too.According to statistics released by the Administrative Office of the U.S. Courts, the September 2022 annual bankruptcy filings totaled 383,810. This means the number of bankruptcies decreased substantially, as 434,540 cases were filed in 2021. As explained, you must prove that paying your student loan debt would cause “undue hardship” and that, if it’s federal student loan debt, you lack the ability to make even the smallest payments under an income-repayment plan.The bankruptcy courts do not use a single test to determine undue hardship but may look at the following factors to determine whether requiring you to repay your loans would cause an such hardship:
If you’re forced to repay the loan, you would not be able to maintain a minimal standard of living.
There is evidence that this hardship will continue for a significant portion of the loan repayment period.
You made good faith efforts to repay the loan before filing bankruptcy.
Government’s New Policy on Student Loan Bankruptcy
In November 2022, the Justice Department and the Education Department announced new procedures that would make it easier for people to make their case for a discharge of student loan debt and increase their chances of receiving at least a “partial discharge.”The goal is to make the procedure to seek bankruptcy for federal student loan debt “fairer and more accessible.”“The Department of Justice, in close coordination with the Department of Education, is implementing a new process at the outset of adversary proceedings in which debtors seek to discharge federal student loans in bankruptcy,” the DOJ announced. “While the bankruptcy judge makes the final decision whether to grant a discharge, the Justice Department can play an important role in that decision by supporting discharge in appropriate cases.”Under the Justice Department’s new process, debtors will complete an “attestation form.”According to the statement, “The Justice Department, in consultation with the Department of Education, will review the information provided, apply the factors that courts consider relevant to the undue-hardship inquiry, and determine whether to recommend discharge. Even where the applicable factors may not support a complete discharge, where appropriate, the Justice Department will consider supporting a partial discharge.”In this new legal process, these three areas will be scrutinized:
Present ability to pay
Future ability to pay
Good faith efforts
“Today’s guidance outlines a better, fairer, more transparent process for student loan borrowers in bankruptcy,” said DOJ Associate Attorney General Vanita Gupta. “It will allow Justice Department attorneys to more easily identify cases in which we can recommend discharge of a borrower’s student loans. We are grateful to the Department of Education for its partnership in developing this guidance.”Consumer bankruptcy lawyers and law professors seem to be taking a “wait and see” approach on student loan bankruptcy.“The new guidance has the potential to provide a meaningful avenue for relief, but its effectiveness will depend on how it is implemented by the Departments of Education and Justice,” said John Rao, staff attorney at the National Consumer Law Center, in an interview with The New York Times.
Can You Declare Bankruptcy With Private Student Loans?
The DOJ policies announced to make bankruptcy proceedings fairer apply to federal student loans. This raises the question of whether it will be more difficult to discharge a debt made up of private student loans in a bankruptcy.The answer: It could be easier to win a discharge of a private student loan debt regardless of the DOJ changes. Since the income-repayment plans don’t apply to private debt, and most banks don’t offer reduce payments based on income, the “hardship” test could be within reach.Legal observers say that private lenders, faced with a bankruptcy, are sometimes willing to accept a negotiated reduction in the overall size of the debt. That is an outcome that can work for both sides.People who feel they were unfairly compelled to keep paying private student loan debts after a bankruptcy can contact the Consumer Financial Protection Bureau to find out their rights.
The Takeaway
Discharging your federal student loans through a bankruptcy proceeding has always been difficult. Proving “undue hardship” and inability to make any payments at all, now or in the future, presented challenges. A recent change in these policies, announced by the Justice Department and Education Department, should make it fairer and more accessible.To learn more about income-repayment plans and other government programs, explore the Federal Student Aid website for additional application instructions and reach out to your loan servicer for assistance. Make sure you’re pursuing a solid program and avoid any student loan forgiveness scams.You can also explore other options for help making your student loan payments more affordable, such as student loan refinancing. Lantern can help you quickly and conveniently compare refinancing options from multiple lenders all at once. Bear in mind that if you refinance your federal loan debt to a private server, that amount does not qualify for government forbearance programs.Learn your personalized rate.
Frequently Asked Questions
Can you file bankruptcy for student loans?
Does bankruptcy clear student loans?
Why is it hard to get rid of student loans through bankruptcy?
Photo credit: iStock/Viktorcvetkovic
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About the Author
Nancy Bilyeau
Nancy Bilyeau writes about student loans, mortgages, car insurance, medical debt and many other finance topics for Lantern. A veteran of the magazine business, she has edited stories on personal finance for Good Housekeeping and DuJour magazines and has written articles for The Wall Street Journal, Readers' Digest, Parade, Town & Country and Lifetime/A&E, among others. She is a graduate of the University of Michigan.
