With the student loan debt crisis at over $1.5 Trillion there are no guarantees of government assistance. Many people are wondering if bankruptcy for student loans is an option.
With the help of exclusive anonymized data provided by Upsolve, LendEDU found that 32% of consumers that file for bankruptcy also carry student loan debt that is virtually impossible to successfully discharge. Within that group, student loan debt comprises 49% of their total debt on average.
So, is bankruptcy for students loans an option?
The answer is yes, but it’s not likely.
There is a common misconception that student loans cannot be discharged in bankruptcy. This misinformation is due in part to the difficulty and rare occurrence of people actually attempting to file. Nonetheless, it is an option that is available.
In order to file bankruptcy for student loans, you must be able to prove that the repayment of your loans is an “undue hardship.”
If you are able to do so, your debts will be canceled in part or in full. Additionally, you will not be subject to collections by your creditors until the courts grant them permission.
But, before I jump into the details let me explain what bankruptcy even is.
What is bankruptcy?
Bankruptcy is the legal process of seeking relief from some or all debt that you cannot pay back to your creditors.
It is widely regarded as a last resort when attempting to reconcile your debts. It is legal in nature and has a significant impact on your financial history.
According to Kassandra Dasent, Personal Finance Consultant & Owner of Minding Your Money, LLC, though it is not ideal, bankruptcy should at least be considered in dire situations.
Individuals experiencing an extended period of unemployment or medical disability who are unable to cover their financial obligations may find this to be their best option.
Types of Bankruptcy
There are two forms of bankruptcy that an individual may file for in regards to student loan debt. Note: If you are considering bankruptcy for student loans, consult a bankruptcy attorney to determine which form is right for you.
Chapter 7 bankruptcy is also known as liquidation bankruptcy. Much like Chapter 13, it can be filed by either an individual or small business owner. There are income limitations that determine eligibility for Chapter 7 filing.
Most types of unsecured debt is discharged under Chapter 7 bankruptcy, . In some cases, the debtor will have to liquidate nonexempt property in order to pay their creditors back.
Contrary to Chapter 7, this form of bankruptcy is designed to pay creditors back via a Chapter 13 repayment plan. This plan lasts between three to five years and the creditor is responsible for paying off their debts in full (although some may be paid in part).
Chapter 13 does not require any form of liquidation. This means that individuals may avoid foreclosure. Additionally, there is no income limit. Though, unsecured debts must fall below roughly $400,000 and secured debts must be under approximately $1M.
The Impact of Bankruptcy
Because of its impact to the filer’s financial history, bankruptcy is considered a last resort option. Here are some of the consequences of filing for bankruptcy.
Drastic reduction of credit score
Dasent states, “A bankruptcy filing will immediately cause one’s credit score to plummet drastically, sometimes as much as 200+ pts depending on how high their score was prior to filing.” A bankruptcy will also remain on your credit report for 7-10 years, depending on which chapter you file.
It becomes public information
As with all legal proceedings, bankruptcy becomes public records when filed. That means that the general public may access this information at anytime through government archives. It will appear in public notices and you will be unable to keep this information confidential.
Co-signers may be liable
Although bankruptcy may cease your creditor’s attempts to collect repayment from you, it may not excuse co-signers. According to Dasent, “creditors still have recourse to pursue payment from a co-signor(s) even when a bankruptcy has been discharged for the individual who filed.” This is particularly true in a Chapter 7 bankruptcy.
What to do Before Filing Bankruptcy for Student Loans
Before filing for bankruptcy, experts recommend alternative methods, such as loan consolidation or restructuring, debt management programs, settlements or negotiations, and coming up with a personal debt payoff plan.
In the case of student loans, there are several options that you should consider before seeking bankruptcy.
Debt Relief Options From Your Lender
Income based repayment
Most lenders offer the opportunity to make payments that are conducive to your income. Give your lender a call to find out exactly how much your payments will be based on your income.
In some cases, you may find that the payment amount may be higher, but it doesn’t hurt to ask.
Public servant loan forgiveness
Public servants have the ability to have their loans forgiven after a certain number of years of service.
If you’re a college student, you may see organizations like Teach for America around your campus recruiting graduates to volunteer as teachers in impoverished communities in exchange for student loan forgiveness.
Deferred payments/hardship plan
If you’ve lost your job or are unemployed, this may be an option for you. Your lender may make arrangements to either defer your payments to resume at a later date or lower your minimum payment, interest, and fees.
Reduced minimum monthly payment
If you’re unable to cover the full amount of your monthly minimum payment, your lender may agree to reducing the payment. Though it may cost you more in the long run, it is a temporary way to relieve the financial strain.
Lower interest rate
Similar to the monthly payment, reducing your interest rate will also reduce that amount that you have to pay each month.
Remove past late fees
If you’re struggling to make your monthly minimum payment, then paying additional late fees will make it almost impossible to get current. Waiving this fee will remove the additional burden and financial obligation. The key however, is to not be late again.
Lump sum settlement
This option entails negotiating with your lender to pay less than what you owe. In order for this to be a viable option in your situation, you’d need a significant amount of cash that you can use to pay off your settled amount immediately.
Proving Undue Hardship
Undue hardship essentially means that you will be unable to prove that repayment of your debts is a hardship on your standard of living. What satisfies as justification of undue hardship will vary by court. The Brunner Test is commonly used to determine undue hardship for student loans.
The criteria that you must meet under the Brunner Test includes:
- By repaying your debt on your current income and with your expenses, you’re unable to maintain a minimal standard of living for yourself and your dependents.
- You’re unable to make payments during a large part of your repayment period due to your current financial situation. (Ex. Medical disability causing inability to work)
- You’ve made good faith attempts to repay your debt. This can mean contacting your lender to work out a plan multiple times, but have still been unsuccessful.
As with any legal matter, you’ll need evidence to support your claim of undue hardship. It is best to work with a bankruptcy attorney so that they can assist you in gathering the proper documentation and/or witnesses and advise you on the validity of your filing.
Filing bankruptcy for your student loan debt is an option, but succeeding may be unlikely. First, use your resources to try to work with your lender on other debt repayment options. You can find additional tips for paying off student loans in this article.