You feel weighed down by the burden of debt to the point that it’s affecting every area of your life. You wonder “can you file bankruptcy on student loans?”
Many people think student loans can’t be discharged in bankruptcy. But there’s a small loophole that can make it possible. It’s rare, but if you’re considering this option, find out how bankruptcy and student loans work.
The history of bankruptcy and student loans
Back in the good old days before 1976, bankruptcy was an option for both federal and private student loans. As time went on, though, legislation changed. In 1998, federal student loans were considered nondischargeable — except in the case of “undue hardship” (more on that later).
Starting in 2005, private student loans were also made nondischargeable by Congress.
Because of these changes, it’s been almost impossible for student loan borrowers to get their loans discharged in bankruptcy.
Student loan debt is outnumbered only by mortgage debt but ranks at the top of household debt, surpassing credit card debt. The amount of debt borrowers have can lead to mental health issues and financial struggles as well as putting life dreams on hold. But only in rare situations is it possible to get your student loans discharged.
How to file bankruptcy on student loans
In order to get your student loans forgiven, you need to prove that paying back your student loans is causing “undue hardship” to you and your family. Whether you file for Chapter 7 or Chapter 13 bankruptcy, you have to do this.
You also must file a separate action called an “adversary proceeding” to determine if you’re experiencing undue hardship.
What qualifies as undue hardship isn’t standardized, but the bankruptcy court may determine undue hardship if:
- You’re forced to repay the loan, you would not be able to maintain a minimal standard of living for you and your dependents.
- There’s evidence that this hardship will continue for a significant portion of the loan repayment period.
- You made good faith efforts to repay the loan before filing bankruptcy.
Another test is the Totality of the Circumstances, where, according to the Federal Register, the court looks at:
- The debtor’s past, present, and likely future financial resources,
- His or her reasonably necessary living expenses,
- Any other relevant facts and circumstances.
Regardless of which test is used, the burden of proof is on you to meet the standard and prove undue hardship. As you can see, there are specific tests the court uses to determine if you qualify for discharging student loans in bankruptcy.
Discharging student loans in bankruptcy is incredibly uncommon. A lot of attorneys would likely advise against it. However, the number may be lower than we think based on who is opting into this process.
According to a paper by Jason Iuliano of University of Pennsylvania Law School, only 0.1% of student loan borrowers filing for bankruptcy attempt to discharge their loans. What’s more compelling is that according to the paper, judges granted undue hardship to 40% of borrowers.
So while it’s extremely rare to discharge student loans in bankruptcy, it’s possible. Iuliano found that many people who were successful in discharging student loans:
- Were not employed
- Had medical issues
- Had very low incomes, such as being near the poverty level
What happens if you pass the undue hardship test
If you do qualify as experiencing undue hardship because of your student loans, several outcomes are possible:
- All of your student loans will be discharged.
- A portion of your student loans will be discharged.
- You pay your student loans with different terms — for example, with a lower interest rate.
Of course, applying for bankruptcy affects your credit. It could drop your score significantly. It will also stay on your credit report for seven to 10 years, depending on the type of bankruptcy you filed.
Student Borrower Bankruptcy Relief Act of 2019
Under current rules, it’s difficult to get student loans discharged in bankruptcy. Though there are currently 15 lawmakers (14 Democrats, one Republican) trying to change that. The Student Borrower Bankruptcy Relief Act of 2019 was recently introduced in May 2019. The bill would cut the undue hardship clause of the current bankruptcy code.
If approved, this law could make it much easier for student loan borrowers to get rid of their debt through bankruptcy.
Alternatives to bankruptcy
Feeling like bankruptcy would be easier but it’s not possible just yet? Consider going on an income-driven repayment (IDR) plan to cap your payments. If you’re near the federal poverty level, your payments could be zero dollars.
You can also go for student loan forgiveness under IDR after 20 to 25 years. You can also pursue Public Service Loan Forgiveness, if you’re eligible. There’s also an Economic Hardship Deferment for up to three years on federal loans if you’re struggling.
These options are available for federal student loan borrowers. Unfortunately, if you’re a private loan borrower, you have fewer resources if you’re struggling with debt. If you feel like you need some guidance on your student loan repayment strategy, get in touch with us for one-on-one help.