Bankruptcy for Students Loans
In this guide, we’ll tell you all you need to know about discharging student loans and filing for bankruptcy, helping you to wipe that slate clean and regain some much-needed financial freedom.
Can Bankruptcy Help with Student Loan Debt?
Bankruptcy can help with unsecured debt, which is debt that’s not secured against an asset. It will either discharge the debt entirely or help you create a repayment plan that will steadily clear it over the next 3 to 5 years.
Follow these steps for a successful bankruptcy case.
Find a Bankruptcy Attorney
Your chances of a successful filing increase significantly when you have a bankruptcy attorney on your side. For Chapter 13, the odds of a successful filing are hundreds of times better, for Chapter 7 they are not as high, but you’re still more than twice as likely to get the results you seek.
Bankruptcy lawyers have been through the process many times before. They understand what the bankruptcy court needs and expects, will ensure that no mistakes are made, and can also advise with regards to exemptions.
Of course, they’re not free, and you could pay anywhere from $1,000 to $4,000 to hire them (depending on location, bankruptcy type, and extenuating circumstances) but they are worth the extra cost.
Choose Your Bankruptcy Code
You can file for Chapter 7 or Chapter 13 bankruptcy as an individual. The bankruptcy code you choose will dictate your exemptions and whether your debts are cleared or restructured. This is something you can discuss with your attorney before filing for bankruptcy.
They will advise on the best option for you after taking all your loan debt, credit card debt, and other debts into consideration.
File a Complaint
To get your private and federal student loans discharged in bankruptcy, you need to file an additional lawsuit known as an adversary proceeding. Your attorney needs to file a complaint that details your case and could lead to a partial or full discharge of your student loan debt.
This process requires you to prove you are experiencing undue hardship and can’t repay your debts. There is no strict definition of undue hardship under the US Bankruptcy Code, but it will be judged on a case by case basis, often using something known as the Brunner Test, discussed below.
What Happens to Student Loans When You File for Bankruptcy?
To clear your student loan debts, you need to pass the Brunner test. Initiated by the bankruptcy court, this test will look at three factors to determine if you’re experiencing hardship.
- Income: Can you maintain a respectable living for yourself and your dependents if you are forced to continue repaying your debts? In other words, how high is your debt-to-income ratio and how much hardship are those debts placing you in?
- Continuity: Is your current state of financial hardship likely to continue for the foreseeable future? Will it last throughout the terms of your loan?
- Good Faith: Have you, in good faith, made a genuine effort to repay your debts?
Pros and Cons of Using Bankruptcy to Clear Student Loans
The benefits of repaying your student loan debts using bankruptcy are clear. You’ll have less debt to worry about, more money in your account at the end of the month, and a higher debt-to-income ratio. Student loan debts can hang around for decades and cause great stress and financial anxiety during that time, so it’s a relief to see these cleared.
However, despite the obvious benefits, there are some pretty big downsides. The first of these concerns bankruptcy itself. Not only will it remain on your credit report for between 7 and 10 years, but for the first few years you may struggle to get a car or home loan and your only options for personal loans and credit cards come with high-interest rates.
It can also cost you several thousand dollars to file and take several months of your time. Simply put, bankruptcy is not something to be taken lightly.
The main issue, however, is that you might not have your student loan debts cleared. It’s difficult to prove hardship and the vast majority of applicants will be dismissed.
If you are over the age of 50, have very little money and likely won’t have much money for the rest of your life, you stand a good chance. However, if you’re young, it’s a different story. Even if you’re poor now, there’s a chance you’ll turn things around, especially if those student loans allowed you to attain qualifications that could potentially lead to an illustrious career.
Repayment Options for Student Loan Borrowers
Bankruptcy is the ultimate last resort for all types of debt. Whether you have lots of credit card debt, federal loans, medical debt or any other form of debt, the bankruptcy court will expect you to exhaust all other options before you file. If you don’t, not only will your federal and private student loans remain, but your case may be dismissed entirely.
You can file again, of course, but that means you’ll pay more filing fees and spend more time completing paperwork. What’s more, if you file many times in a short period, they may dismiss your case with prejudice, effectively banning you from a repeat filing for a fixed period of time.
So, before you settle on bankruptcy as the right option, make sure you have exhausted all other possibilities. These will differ depending on whether you have private or federal loans, but we have discussed both options below.
Other Repayment Options for Federal Loans
Federal loans are much more forgiving than private loans, with grace periods that defer all student loan payments; income plans that only charge when you earn, and more. As a federal loan debtor, you generally have more control and more options, including:
Also known as Pay as you Earn (PAYE) these repayment options are structured around your income and there are four of them in total.
Income-driven repayment is typically set at between 10% and 20% of your discretionary income, which is the money you have left after paying taxes and necessary living expenses. These repayment plans extend your loan term to between 20 and 25 years and change yearly based on your income, so they could charge as little as $0.
The best student loan repayment option is to clear those debts in one fell swoop and be free of the responsibility. This is essentially what loan forgiveness programs offer. This option isn’t available to everyone and there are some complications involved, but if you work in the public sector, including education, health, and military, then you may qualify.
This option is much better than having debt discharged in bankruptcy, as it won’t do damage to your credit score or credit report, nor will it impact your future prospects as a borrower.
Standard Repayment and Extended
A standard repayment plan is structured over 10 years, with fixed monthly payments made during this time. You’ll pay less in interest than you would with an extended repayment, which is based over 25 years and also sets fixed monthly payments.
The standard option is ideal for student loan borrowers seeking help with their payments while also looking to keep the total interest and term to a minimum. However, if you simply can’t meet the payments, can’t get anything discharged in bankruptcy, and don’t qualify for loan forgiveness, then the extended repayment period is a good option.
Other Repayment Options for Private Student Loans
If you’re a private loan debtor, then repayment options diminish somewhat and the debt becomes more problematic. Private loan debt, in many ways, is just like any other private debt, with the lender focused only on recovering that loan debt as quickly and completely as possible.
Still, there are options for debt relief that can help you.
As a borrower of any unsecured debt, you always have the option of debt consolidation, whereby you can consolidate multiple debts into one. This is a great option if you have private loan debts that are spiraling out of control and are also burdened with credit card debt and other types of debt.
Unlike when you get these debts discharged in bankruptcy, you will be required to make regular payments and the debt will remain until you pay it off in full. However, it can provide you with some reprieve by lowering your payments, essentially creating a repayment plan that makes the debt more manageable.
While the lender is focused purely on profit, they may still be willing to negotiate a repayment option that makes your debt more manageable. These options are often provided to debtors struggling with financial hardship, such as the loss of a job or medical issues.
The ultimate goal of these companies is to reclaim as much of their money as possible, with everything else being a bonus. If they can improve their chances of reclaiming their money by offering you more favorable terms and/or a short-term grace period, they’ll typically be happy to do it.