Many people, lawyers included, believe that you can't discharge student loans in bankruptcy. But that's not true. There's a process you can follow to try to have your student loans discharged, called an adversary proceeding. Read this guide to understand that process and how student loan bankruptcy works.
What is student loan bankruptcy?
Student loan bankruptcy refers to the process where a debtor files bankruptcy and then files a complaint to discharge their student loan debt. Under bankruptcy law, there's not a specific type of student loan bankruptcy. Instead, most people file what is referred to as consumer bankruptcy cases, Chapter 7 and Chapter 13.
Filing bankruptcy under either of those chapters will get rid of credit card debt, medical bills, personal loans, repossessions, etc. But it doesn't get rid of all types of debts. Some debts will still remain until you file a lawsuit called an adversary proceeding. Student loans are one of those types of debts that remain.
- Do I have to be in default to file student loan bankruptcy? You don't have to be in student loan default to file bankruptcy. You can file bankruptcy if your loans are in good standing. However, filing bankruptcy will stop student loan wage garnishment, tax refund offset, and Social Security Benefit offset if you are in default.
- Which bankruptcy is the one to file if it's just credit cards and student loans? Most borrowers with credit card and student loan debt will want to file Chapter 7 bankruptcy. It's cheaper and faster than Chapter 13. But to qualify for Chapter 7, you'll need to pass the means test.
- In what states are student loans discharged in bankruptcy? You can file bankruptcy and get a discharge of student loans in all states if you meet the undue hardship standard.
- How often are student loans discharged in bankruptcy? A study in the American Bankruptcy Law Journal showed that 4 out of 10 borrowers were able to get a partial discharge or full discharge of their student loan debt. Despite that success, 0.1% of borrowers who file bankruptcy ever try to get rid of their student loans.
- How do I know if my student loans were discharged? The one way to know for sure that your student loans were discharged is to file an adversary proceeding and get a court order discharging your loans. If your student loan accounts show on your credit report as $0 after filing bankruptcy, that doesn't mean your loans were discharged.
Why student loan debt is treated differently
Over the years, Congress has decided that good reasons exist to stop people from getting rid of their debts by declaring bankruptcy. For instance, Congress has made child support, alimony, certain tax debts, and criminal restitution non-dischargeable. The need to protect those types of debts from discharge is obvious. But after the federal government decided to start offering federal loans, Congress chose to do the same for student loan debt.
Student loans became non-dischargeable in the late 1970s when Congress added Section 523(a)(8) to the U.S. Bankruptcy Code. The thinking was that the U.S. Department of Education should be protected from borrowers racing to bankruptcy after graduating. Over the years, Congress has amended Section 523(a)(8) to protect different types of federal loans (e.g., Direct Loans, Federal Family Education Loans (FFEL), and Federal Perkins Loans) and private loans.
Currently, Section 523(a)(8) protects a student loan from discharge absent undue hardship if:
- it was made or insured by the federal government
- it was made under a loan program funded by the federal government or a nonprofit
- it is a qualified education loan according to the IRS's criteria
All federal student loans are protected from student loan bankruptcy discharge. However, some private loans may not be. You can read more about discharging private loans here.
Student Loan Bankruptcy: The Process
For many people, student debt is the one debt they can't seem to overcome no matter what they do. They've made payments when their financial situation allowed. Asked for deferments and forbearances when they couldn't. They've applied for loan forgiveness and lower interest rates. And they've even asked for options to reduce their outstanding student loan debt via settlement.
Nothing has worked thus far.
It's at that point that filing student loan bankruptcy becomes an option.
When to file student loan bankruptcy?
There's no set time to file student loan bankruptcy. You can file it before your bankruptcy case closes. Bankruptcy law also allows you to file it after the court closes your bankruptcy case.
From my perspective as a student loan lawyer, I recommend people should consider filing student loan bankruptcy when:
- they can no longer afford their private student loans and can't afford a settlement
- they have a physical disability that limits their ability to work but does not qualify them for a total and permanent disability discharge
- they have defaulted a second time on a federal student loan and can't get out of default
- they cannot get a professional license (e.g., medical school graduates, law school graduates, etc.)
- their elderly and have made a good faith effort to repay their student loans
If you decide you're ready to file student loan bankruptcy after looking at your situation, the next step is to meet with a bankruptcy attorney to determine what bankruptcy you should file, Chapter 7 or Chapter 13.
Chapter 7 Bankruptcy
Completing Chapter 7 will eliminate your consumer debt (credit cards, medical bills, etc.). But it won't automatically wipe out student debt. The discharge order you received from the court says you've received a discharge of debts you're entitled to receive a discharge, which does not include child support, certain debts owed to the government (e.g., tax debt), and student loans.
People often believe Chapter 7 discharged their student loan debt because they check their credit reports and their student loan accounts are closed. But that's just a mark on a credit report indicating your account was closed with one creditor. You still owe the loans. Most likely, your loan will be sent to another collection agency or loan servicer who will start demanding student loan payments.
Filing Chapter 7, by itself, does not get rid of student loan debt.
You have to file an adversary proceeding asking the court to discharge your student loan debt. Until you do that, you remain responsible for your student loans.
- Does Chapter 7 include student loans? Your student loans will be listed on your Chapter 7 bankruptcy paperwork, but they will not be discharged at the end of your case. Instead, you'll need to file an adversary proceeding to discharge your student loan debt.
- Can you get financial aid while in chapter 7? You can get federal financial aid while in Chapter 7. Federal law prohibits the government from refusing you access to student loans and grants because you've filed bankruptcy. However, filing bankruptcy is considered an adverse event, which can make graduate students and parents ineligible for Plus Loans.
Chapter 13 Bankruptcy
When you file Chapter 13, your bankruptcy attorney will prepare a plan to repay your secured debt and unsecured debt over the next 3 to 5 years. Your student loans will be included in that Chapter 13 plan. However, many debtors complete that plan, having never made a payment towards their student loan debt.
As a result, their loan balance grows, and they miss out on earning credit towards student loan forgiveness programs like income-driven repayment plan forgiveness and Public Service Loan Forgiveness. Read this guide to understand what to do with your student loans in Chapter 13.
When to file an adversary proceeding
After you file bankruptcy, the next step to get a student loan discharge is to file an adversary proceeding. An AP is what lawsuits are referred to as in bankruptcy proceedings.
A borrower or cosigner can start the student loan bankruptcy process by filing an adversary proceeding asking the bankruptcy judge to discharge federal loans or private loans due to undue hardship.
Chapter 7 bankruptcy cases are over with quickly (2-4 months). As a result, you may need more time to give yourself a better chance of getting a discharge. Fortunately, Federal law does not set a deadline for filing an adversary to discharge student loans. So can file the AP before or after your case closes.
Chapter 13 cases take 3 to 5 years to complete. You don't receive a discharge until after you made your final payment under your plan. Consequently, different jurisdictions may force you to wait until your Chapter 13 is almost over before they'll let you file an adversary proceeding.
Bankruptcy law doesn't define undue hardship for student loans. As a result, whether your student loans are causing you an undue hardship or just ordinary financial hardship is decided by your bankruptcy judge.
Most bankruptcy judges use the Brunner Test to see if borrowers meet the undue hardship. The Brunner Test is a three-part test that looks at your (1) current income, (2) potential future income, (3) and past good faith effort to make monthly payments on your student loans.
Bankruptcy judges in Arkansas, Iowa, Minnesota, Missouri, and the Dakotas use the totality-of-the-circumstances test. The totality of circumstances test looks at the same things the Brunner Test test looks at. However, it also allows judges to see if additional circumstances make student loan repayment an undue hardship for you.
Cost to File Bankruptcy On Student Loans
The bankruptcy court does not charge court fees to file student loan bankruptcy. However, the fee you paid your bankruptcy attorney to file Chapter 7 or Chapter 7 did not include the attorney filing an adversary proceeding for student loans. Therefore, unless you find an attorney willing to file the AP at a reduced rate, you may have to spend several thousand dollars hiring a student loan bankruptcy lawyer.
Changes to Bankruptcy Law
Over the years, different members of Congress have introduced legislation to make student loans dischargeable in bankruptcy like other types of debts. But, unfortunately, that legislation has gone nowhere.
And while America waits for Pres. Joe Biden to forgive student loan debt, another proposal to change the treatment of student loan debt in bankruptcy was introduced, this time by Sen. Elizabeth Warren. Sadly, like the legislation before it, the Consumer Bankruptcy Reform Act of 2020 has yet to go anywhere.
Alternatives to Student Loan Bankruptcy
Bankruptcy is not the best fit for everyone. Here are some options to consider to help you deal with your student loan debt:
Refinance for a lower interest rate. Depending on your student loan balance, credit score, and income, you may be able to find a lender that offers a much lower interest rate. While refinancing won't get rid of the debt, the lower interest rate may make it easier to pay off your loans faster.
Request a deferment or forbearance. If you're struggling with your private student loans, ask for a deferment or forbearance to give you some relief. You can also ask your student loan servicer if they offer interest rate reduction programs and other flexible repayment options.
Apply for an income-driven repayment plan. IDR Plans are affordable repayment plans offered by the federal government to federal student loan borrowers. These plans allow you to pay 10 to 15% of your discretionary income for 20 to 25 years. Any loan balance remaining after you make your final payment will be forgiven.
Check eligibility for discharges. The federal government and some private lenders will discharge your student loan debt due to total and permanent disability. You may also be entitled to a discharge if your school misrepresented your ability to transfer credits or get a job or if the school closed.
Want help filing student loan bankruptcy? Let's talk
The process to get a hardship discharge of your student loan debt can be intimidating. Not only do you have to file bankruptcy, but you also have to pass different tests and provide evidence of your current financial situation and reasonably reliable future income. On top of that, you have to show your inability to repay your loans will last for a significant portion of the repayment period of the student loans.
If all of this seems like a lot, let me help. I've helped many student loan borrowers just like you file student loan bankruptcy. Schedule a free 10-minute talk so we can discuss how I can help you do the same.