If you’re overwhelmed by student loan debt and can’t make ends meet, you may be wondering if you can file for bankruptcy on student loans.
The truth is that federal and private student loans are difficult but not impossible to erase in bankruptcy. That’s because you must typically take the extra step of filing an adversary proceeding and prove that repayment would cause an “undue hardship.”
But recent changes to the bankruptcy discharge process are designed to reduce the burden on federal student loan borrowers and make the process more consistent. Here’s what to know if you are considering this route.
[Read: Best Private Student Loans.]
Can You File for Bankruptcy on Student Loans?
Yes, you can file for bankruptcy on student loans. But to successfully discharge the debt, you will need to show that repayment poses an undue hardship.
Because the bankruptcy code does not define undue hardship, the standard is left open to judicial interpretation. This can make it difficult to know whether your loans would be dischargeable, but it also gives judges the flexibility to decide on a case-by-case basis.
In November 2022, the Justice and Education departments released guidance for a new process with clearer standards for borrowers seeking to discharge federal student loans in bankruptcy. The process includes a review of the borrower’s past, present and future financial circumstances, taps Education Department data, and uses a borrower-completed form to help the government assess the discharge request.
The “guidance outlines a better, fairer, more transparent process for student loan borrowers in bankruptcy,” said former Associate Attorney General Vanita Gupta in a statement. “It will allow Justice Department attorneys to more easily identify cases in which we can recommend discharge of a borrower’s student loans.”
How Does Student Loan Bankruptcy Work?
Start by finding an experienced attorney to help you discharge your student loans in bankruptcy. While not required, a lawyer is strongly recommended by the U.S. court system to guide you through the complex process.
The attorney will help you prepare your case and choose which type of bankruptcy to file. Chapter 7 bankruptcy allows you to erase most of your unsecured debts, while Chapter 13 requires you to restructure and repay some or all of your debts over time.
If you hope to discharge federal student loan debt, you must fill out an attestation form to provide information to the government about your loans and finances.
You also need to file an adversary proceeding asking the court to discharge your student loans in bankruptcy. This is a lawsuit filed separately from, but related to, your bankruptcy case to demonstrate undue hardship.
Filing Bankruptcy: Chapter 7 vs. Chapter 13
If you’ve decided to pursue bankruptcy, you would first need to decide which option best fits your situation: Chapter 7 or Chapter 13. Weigh the pros and cons of each when deciding.
Chapter 7 Bankruptcy
This is the most common type of consumer bankruptcy because it allows you to erase most unsecured debts, such as credit cards, student loans and medical bills. Some filers are required to sell their assets to satisfy their debts, but most filers can protect all of their property. If you’re successful in bankruptcy court, the Chapter 7 filing can stay on your credit report for 10 years from the date of discharge.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is known as a “wage earner’s plan” because it’s reserved for people with a regular income. When you file for Chapter 13 bankruptcy, you will make a plan to pay back all or some of your debt over three to five years. The court will then discharge any remaining balances. This type of bankruptcy can remain on your credit report for seven years.
The decision to file for Chapter 7 or Chapter 13 bankruptcy comes down to whether you pass the income test and whether you have assets, says Stanley Tate, a student loan lawyer.
“Most people who want to get rid of their student loans in bankruptcy want to do a 7 because it’s cheaper and faster than a 13,” Tate says. “But if you have high income or equity in your home, a 13 may be where you end up.”
Preparing the Attestation Form
You and your bankruptcy attorney will need to complete an attestation form, which the Justice and Education departments will use to determine your eligibility for discharging federal student loans through bankruptcy. The form asks for your household income and expenses, family size, and details such as previous efforts to repay the debt.
“The standardized form is new, allowing for better uniform decision-making,” says Amy Lins, vice president of customer success at Money Management International, a nonprofit financial counseling agency. For instance, the form is designed to standardize key definitions such as “minimal standard of living” and “ability to repay,” Lins says.
The Justice and Education departments will review your attestation form and may recommend a discharge. However, the judge will make the final determination of whether you’ve met the undue hardship standard.
Filing an Adversary Proceeding
If you want to discharge your federal student loans in bankruptcy — and to discharge most private student loans — you will need to file an adversary proceeding.
An adversary proceeding is where you’ll explain how your student loans are causing undue hardship. You can use the information in your attestation form and will need to provide documents to support your claims.
And keep in mind: If your federal student loans are discharged in a pretrial settlement, you may be able to use that information to bolster your case for discharging a private loan, Lins says.
However, some private loans may not require you to file an adversary proceeding and show proof of undue hardship. Certain loans can be discharged in a normal bankruptcy proceeding, according to the Consumer Financial Protection Bureau. Examples include loans for fees and living expenses during medical or dental residency, loans for fees and expenses incurred while studying for the bar exam, and loans that exceeded a school’s cost of attendance.
How to Prove Undue Hardship for Student Loans
The courts use different tests for determining undue hardship. The most common framework for assessing undue hardship is the Brunner test, according to the Justice Department.
Brunner Test
The courts look at three criteria:
1. You can’t maintain a minimal standard of living for you and your dependents if required to repay your student loans.
2. This financial situation isn’t likely to change for most of your student loan repayment period.
3. You’ve made good faith efforts to repay your student loans.
Other courts have used a “totality of circumstances” test to evaluate whether repayment would cause undue hardship.
Totality of Circumstances Test
The test also looks at three factors:
1. What are your past, present and future financial resources?
2. What are reasonable living expenses for you and your dependents?
3. What are other relevant facts and circumstances, including your past efforts to repay the loan?
A few outcomes are possible based on what the bankruptcy court determines. You might expect one of the following scenarios:
— If your student loans are fully discharged, then you won’t owe anything else on the loan and all collection activity will stop.
— With a partially discharged student loan, you will need to repay some portion of the debt.
— A restructured loan involves repaying some or all of the debt but with different terms, such as a lower interest rate than you’re currently paying.
[Read: Best Student Loan Refinance Lenders.]
Alternatives to Bankruptcy for Student Loans
— Apply for a federal income-driven repayment plan. Income-driven repayment, or IDR plans, which are only available for federal student loans, base your monthly payment on your income and family size. In some cases, your monthly payment could be as low as $0. Any remaining loan balance will be forgiven after you’ve made payments on an IDR plan for 20 to 25 years.
— Enroll in federal loan forgiveness programs. If you work for a qualifying government or not-for-profit organization, you might be eligible for Public Service Loan Forgiveness. This program forgives the balance on your federal student loans after you make loan payments for 10 years while working full time for a qualifying employer. Or you may be eligible for federal student loan forgiveness of up to $17,500 through the Teacher Loan Forgiveness Program.
— Ask about deferment or forbearance options. These short-term solutions allow you to temporarily stop making your federal student loan payments or reduce the amount you pay each month. The difference between the two is that interest will continue to accrue on your loan balance if you are in forbearance, but not if you are in deferment. Private lenders may offer these options at their discretion. With federal student loans, a variety of circumstances may qualify you for a deferment or forbearance, and you will need to request it from your loan servicer. However, “Deferment and forbearance don’t solve the problem,” says Jay Fleischman, a student loan lawyer. “They merely delay repayment.”
— Refinance your student loans. You can refinance federal and private student loans by taking out a new private loan to pay off your original debt. You’ll then make payments on the new loan over time. This may be a good option if a private lender offers a lower interest rate than what you’re paying now. But it’s “seldom a good option for federal student loans,” Fleischman says, because you’ll lose important protections in the process.
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Can You File for Bankruptcy on Student Loans? originally appeared on usnews.com
Update 04/29/24: This story was previously published at an earlier date and has been updated with new information.
