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Getting your student loans discharged through bankruptcy is not impossible, but it is difficult. To qualify for student loan bankruptcy, you’ll need to prove your loans pose “undue hardship.” This requirement is stricter than what you typically see for other types of debt, like credit cards or personal loans. What’s more, the decision of whether or not you qualify for bankruptcy is up to each individual court’s judgment. Because there’s no guarantee that you’ll qualify — and the costs of going to court can be high — it’s typically worth exhausting your other options for student loan relief before pursuing bankruptcy proceedings.
What Is Bankruptcy?
You might think bankruptcy automatically wipes away all your debts, but the reality is not so straightforward. There are two types of bankruptcy for individuals, and neither gets rid of your debt without consequence. You might have to sell your eligible assets to pay off your debt (Chapter 7 bankruptcy), or you’ll be required to pay back a certain amount under an agreed-upon repayment plan for three to five years (Chapter 13 bankruptcy). While your remaining debt can be discharged, your credit score will be significantly damaged, The bankruptcy will remain on your credit report for years, making it difficult to qualify for new loans, credit cards, or other financial products. All that said, bankruptcy could be a useful avenue for borrowers who are overwhelmed with student loan debt and have exhausted their other options for relief.
What Is Student Loan Bankruptcy?
When students are still in college, they may try hard to get a scholarship in order to avoid loans. But sometimes there’s no other option than to get loans.There’s no specific bankruptcy for student loan debt. As a borrower, you would file for Chapter 7 or Chapter 13 bankruptcy for your student loans. But unlike with some other types of unsecured debt, you’ll need to prove that your student loans cause “undue hardship” to you and any dependents. Many courts rely on the Brunner test to determine whether your loans cause undue hardship. Using this test, you’ll need to show that,
Your student loan payments prevent you from maintaining a minimal standard of living with your current income and expenses
Your situation is unlikely to improve throughout the remainder of your loan’s repayment term
You’ve made a “good faith” effort to pay off your loans to the best of your ability
As you can see, the requirements for filing bankruptcy on student loans are somewhat vague, making it difficult to predict whether you’ll be successful in a bankruptcy court.
How Student Loan Bankruptcy Works
Filing for student loan bankruptcy is a complicated process. Due to this complexity, you’ll likely want to hire a lawyer to help you go about it the right way. Your first step will be completing a credit counseling course. After you’ve completed this mandatory course, you’ll submit details about your financial circumstances to a U.S. bankruptcy course. Student loan borrowers who are filing for bankruptcy also must file an adversary proceeding. With this adversary proceeding, you’re requesting that the court determines whether or not your loans pose undue hardship. Finally, you’ll need to pay a fee to file bankruptcy, as well as any fees charged by your student loan attorney. The details of the process may also vary depending on whether you’re filing for Chapter 7 or Chapter 13 bankruptcy (more details on these types of bankruptcy below).
Can You File Bankruptcy on Student Loans?
As an individual consumer, you have two main options when it comes to filing for bankruptcy: Chapter 7 and Chapter 13. The type you choose largely depends on whether you have the means to repay a portion of your debt.
Chapter 7 Bankruptcy
If you qualify for Chapter 7 bankruptcy, your student loan debt will be completely discharged — but you’ll need to sell off your nonexempt assets to help cover costs. The status of your assets varies by state, but exempt assets typically include your primary home, vehicle, and personal possessions. Other assets, however, can be sold off to pay off your creditors. Any remaining student loan balance will be discharged. Note that some debts can’t be discharged through Chapter 7 bankruptcy, including taxes and child support. This form of liquidation bankruptcy will stay on your credit report for 10 years.
Chapter 13 Bankruptcy
While Chapter 7 bankruptcy liquidates your assets to pay off your debts, Chapter 13 bankruptcy reorganizes your debt into a new repayment plan. Through Chapter 13, the court will create a new repayment plan for your debt that spans three to five years and uses up to 100% of your disposable income. The court will decide how much your monthly payments will be, as well as how to distribute those payments to your creditors. Chapter 13 bankruptcy can be helpful if you’ve run out of options for lowering your monthly student loan payment. This may be more likely if you have private student loans, since federal student loans are eligible for a variety of repayment plans.
Alternatives to Filing for Bankruptcy
Filing for bankruptcy can be expensive and stressful, and unfortunately there’s no guarantee that a court will determine you pass the test for undue hardship. Before going to court, consider alternative options for managing your student loan debt, such as applying for income-driven repayment, student loan consolidation, or student loan deferment.Another option is to see if you obtain student loan employer payment plans.
Income-Driven Repayment Plans
Of course everyone would prefer to pay off student loans fast. Sometimes it’s not possible.If you hold federal student loans, you could adjust payments by applying for an income-driven repayment plan. You have four income-driven options, and all of them adjust your monthly payments to a percentage of your discretionary income. If you make on-time payments and still have a balance after 20 or 25 years, it will be forgiven. You can apply for an income-driven plan on the Federal Student Aid website. When you apply, you can request a specific plan or ask your loan servicer to select whichever plan would give you the lowest monthly payment.
Federal Loan Rehabilitation
If your federal student loans have gone into default, you have two options for getting them out: rehabilitation or consolidation. With rehabilitation, you agree to make nine on-time payments that equal 15% of your discretionary income. Once you’ve made these payments, your loans will be back in good standing and the default can be removed from your credit report. You can also apply for a new repayment plan at this time to make your monthly bills more affordable.
Federal Loan Consolidation
Your other option for getting federal student loans out of default is consolidation. While rehabilitation takes nine months, consolidation only requires three months of on-time payments or an agreement to pay back a consolidation loan on an IDR plan. But while consolidation helps revive your loans faster than rehabilitation, it doesn’t have the benefit of removing the default from your credit report. Note that you can apply for consolidation even if your student loans aren’t in default. Applying for consolidation can help you simplify repayment by combining multiple loans into one. Plus, you can choose a new repayment plan of up to 30 years.
Private Loan Modification or Settlement
Private student loans are unfortunately not eligible for the federal programs described above. Your options for adjusting payments or getting out of default will depend entirely on your lender. If you’re close to falling behind on payments — or if you already have — speak with your lender or loan servicer about your options. A lender might offer forbearance, deferment, or an adjusted payment to help you stay out of default. If your loans have already gone into collections, you might be able to negotiate a lump sum settlement. Sometimes, a collections agency will accept a smaller amount to pay off your balance if you pay it all at once. It’s worth noting that unlike federal student loans, private student loans have a statute of limitations. After this period has passed, collections agencies can no longer demand repayment from you. However, they can bring you to court during this time. If you start to negotiate a settlement with a collections agency, this communication could restart the statute of limitations on your private student loan debt.
Consider the Best Student Loan Refinancing Options With Lantern
Another option for managing your debt is refinancing your student loans with a new lender. Depending on your credit and income, you could qualify for a lower interest rate through refinancing, as well as choose new repayment terms. Not every borrower will qualify for refinancing, however, and it’s not the best move for everyone. If you refinance federal student loans, for example, you’ll lose access to federal plans and programs, such as income-driven repayment and loan consolidation. Make sure you understand the disadvantages of refinancing student loans before you apply.Refinancing private student loans, however, typically doesn’t carry the same level of risk. If you’re interested in refinancing your loans, Lantern can help you find and compare student loan refinance rates.
Frequently Asked Questions
Can I end up owing more if I file for student loan bankruptcy?
Should I file for bankruptcy if my only debt is student loan?
What determines the chance of discharging a private student loan in bankruptcy?
How much does it cost to file for student loan bankruptcy?
Photo credit: iStock/BrianAJackson
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About the Author
Rebecca Safier
Rebecca Safier has nearly a decade of experience writing about personal finance. Formerly a senior writer with LendingTree and Student Loan Hero, she specializes in student loans, financial aid, and personal loans. She is certified as a student loan counselor with the National Association of Certified Credit Counselors (NACCC).
