The common belief is that student loans and bankruptcy do not mix. Generally, student loan debt may not be discharged in bankruptcy; however, there are exceptions.
Understanding Bankruptcy and Student Loans
Most individual debtors file under either Chapter 7 or Chapter 13 of the Bankruptcy Code.
- Chapter 7 bankruptcy seeks to have debts discharged completely but requires the debtor to demonstrate that their income is so low that they can’t meet basic living costs and have anything left over to pay toward their debts. This is similar to what is required for a student loan bankruptcy discharge.
- Chapter 13 bankruptcy results in a plan to pay some or all of your debts over three to five years. Part of your debts can be discharged, but maybe not all of them. This is designed for those who have something left over to pay toward their debts after meeting basic living expenses. You won’t get student loan forgiveness in Chapter 13, but you may be able to pay a reduced monthly payment on your student loans during the payment period.
Can You File Bankruptcy on Student Loans?
Certain debts may not be discharged in bankruptcy. Student loans are in the category of nondischargeable debts; however, the bankruptcy law makes an exception where the student loan debt “would impose an undue hardship on the debtor and the debtor’s dependents.”
The Bankruptcy Code does not define “undue hardship,” so the bankruptcy judge must decide the matter. You must show that you have a greater hardship than that normally faced by someone filing bankruptcy. Bankruptcy courts apply various tests to determine whether there is undue hardship. The most common tests are the Brunner test and the Totality of Circumstances Test.
The Brunner Test requires you to meet all of the following requirements:
1. Considering your current income and expenses, you cannot maintain a minimal standard of living for yourself (and any dependents) if you are required to repay your student loans.
2. Your current financial situation is unlikely to improve for a significant portion of the loan repayment period.
3. You have made a good faith effort to repay your student loans.
Under the Totality of Circumstances test, the court looks at “all relevant factors” to decide whether an undue hardship exists. This leaves it up to the judge to determine the “relevant factors.” If you have a Health Education Assistance Loan (HEAL), the loan must have become due more than seven years ago, and you must satisfy the judge that repayment would create an “unconscionable burden” on you.
Some bankruptcy courts use other tests. You would need to find out which test is used in the Bankruptcy Court to file your case. With any test, the courts are reluctant to find undue hardship.
How Likely Is a Discharge?
It is difficult to say how likely a discharge is. A 2011 study showed that bankruptcy filers attempted to discharge student loans in only one-tenth of one percent (0.1%) of cases. However, of those few who did, about forty percent (40%) were successful in having at least some student loan debt discharged.
Student Loan Debt Discharge Procedure
To seek discharge of student loans, you need to file an adversary procedure, which is a lawsuit within the bankruptcy case. You would file a Complaint to Determine Dischargeability, then have to go to court to prove undue hardship. This is not a simple matter, and it would be advisable to consult a bankruptcy attorney.
For people in financial straits and have a lot of debt other than student loans, bankruptcy may be a good idea. However, what might be called “student loan bankruptcies” are usually not advised for those who have little or no debt other than student loans.
An Alternative Within Bankruptcy
Rather than seek a discharge, some have successfully challenged the validity of a student loan on the grounds of breach of contract, fraud, or unfair or deceptive business practices (often when a for-profit school is found to have made deceptive claims of employability upon graduation).
Also, to qualify as a nondischargeable student loan, the loan must be for a school eligible for a federal student aid program.
If the school was not eligible, the loan is dischargeable. In bankruptcy, the lender must file a Proof of Claim. You would file an Objection to Proof of Claim to challenge the loan's validity.
There are several alternatives to bankruptcy that may help you resolve your student debt problem. To explore any of these alternatives, you should contact your student loan lender.
- Repayment Options. Some student loans have payment options considering your financial situation, such as lowering the monthly payment and extending the payment period.
- Deferments. This is where payments are temporarily delayed for certain circumstances, such as unemployment, economic hardship, being in school, public or military service, parental leave, being a working mother, and temporary disability. The requirements vary, and interest may accrue during the deferment period.
- Forbearance. This allows for a temporary postponement of payment, reduced payment amount, or extension of time. You may qualify even if you don’t qualify for a deferment. Interest charges accrue, although you may be able to make interest-only payments to prevent an increase in the amount you owe.
- Forgiveness or Cancellation. For those in certain careers or who are disabled, a student loan may be forgiven. Typical careers allowing forgiveness are in education, government, or the military. Loan cancellation might be possible if your school closed while you were attending or committed fraud.
- Consolidation. If you have more than one federal student loan, you may be able to consolidate them into one new loan, usually with a smaller monthly payment over a longer period of time. This may be done regardless of whether you are in default. This will be a new loan, with its own requirements, which may be different from the loans it replaces.
- Loan Rehabilitation. This is only for federal student loans in default. You must make certain payments over a ten-month period, then begin a new payment arrangement. Only certain loans qualify, and you may only do this once.
- Default Repayment Plan. This is also for those in default and involves working with your lender to set up a repayment plan that you can afford.
While it isn’t often that student loans are forgiven in bankruptcy, don’t give up on using bankruptcy to get relief from your student loans until you’ve explored whether you might qualify for an exception to the general rule. Also, don’t neglect your various non-bankruptcy options.