How to File Bankruptcy on Student Loans
The key to discharging your student loan debt by filing for bankruptcy is to prove undue hardship. However, because filing bankruptcy has long-term financial consequences, we recommend only doing so as a last resort.
According to the National Student Loan Data System (NSLDS), a staggering $1.6 trillion in student loan debt burdens over 43 million Americans. Although a last resort, bankruptcy offers a potential path for those overwhelmed by student loan debt. This guide will walk you through the process of filing for bankruptcy on your student loans, explore other ways to manage your debt and help you lay the groundwork for a more secure financial future.
How Student Loan Bankruptcy Works
Student loan bankruptcy is a legal avenue allowing you to seek relief from your student loan debt. Unlike other debts, student loans aren't automatically discharged in bankruptcy. Borrowers must file an adversary proceeding and prove undue hardship to qualify for student loan debt forgiveness. Courts evaluate factors like income, expenses and overall loan burden, often using criteria like the Brunner test or the Totality test to determine eligibility.
Chapters 7 and 13 are distinct chapters under the U.S. Bankruptcy Code that offer different paths for debt relief. Chapter 7, often called "liquidation bankruptcy," allows individuals to discharge certain debts after non-exempt assets are sold to repay creditors. Chapter 13, known as "reorganization bankruptcy," enables individuals to create a repayment plan to pay back all or a portion of their debts over three to five years.
When considering student loan bankruptcy, it's essential to understand these chapters, as they provide different mechanisms and requirements for potentially discharging student loan debt.
Recent guidelines from the U.S. Department of Justice and the U.S. Department of Education have made the bankruptcy discharge process more transparent and fair for individuals with student loans. However, it's important to note that federal student loans are less likely to be discharged due to their repayment options and strict undue hardship standards.
How to File Bankruptcy for Student Loans
Filing for bankruptcy to discharge student loan debt is a complex and consequential decision. Here are some first steps you can take.
1. Work With a Lawyer
Navigating the complexities of bankruptcy is a task best tackled with professional help. Although you can technically file independently, an experienced attorney can guide you more effectively and protect your consumer rights. When choosing a lawyer, seek one with specialized knowledge of student loans, good communication skills and transparent pricing. During your initial consultation, discuss your student loan debt and the likelihood of its discharge to gauge if the attorney can meet your specific needs.
Multiple avenues exist to find affordable and accessible legal help for your student loan bankruptcy case, including:
- Legal Aid Services. Organizations like the Legal Services Corporation offer free legal assistance to those who meet income eligibility requirements.
- Pro Bono Attorneys. Some lawyers offer pro bono services, representing you for free. Websites like ProBono.net can help you find such attorneys in your area.
- Online Resources. Websites like Avvo and FreeAdvice provide free legal advice and templates.
- Community Centers and Law Clinics. Many universities and community centers offer free legal clinics where law students provide free legal advice under the supervision of qualified attorneys.
- State Bar Associations. These organizations often have directories and resources for free or low-cost legal help. Check your state's bar association website for more information.
2. Decide on Chapter 7 or Chapter 13 Bankruptcy
Choosing between Chapter 7 and Chapter 13 bankruptcy is critical in your financial recovery journey. Your choice will influence how your assets are managed, the length of the bankruptcy process and the types of debts that can be discharged. Chapter 7 is generally quicker but may require you to liquidate some assets. On the other hand, Chapter 13 allows you to keep your assets but involves a three- to five-year repayment plan. According to the U.S. Courts, between 2005 and 2021, 67% of non-business bankruptcies filed were Chapter 7, and 32% were Chapter 13.
Wage Earner's Plan
Limited income and assets; must pass a means test or have income below state median.
Steady income; total secured and unsecured debt must not exceed $2,750,000
Credit Score Impact
Softer impact; remains on report for 7 years
Risk of losing valuable assets
Lower risk; allows for debt restructuring
You're ineligible for Chapter 7 if you've had another Chapter 7 discharge within the past eight years
The process involves creating a repayment plan that allocates up to 100% of your disposable income towards debt repayment.
3. File an Adversary Proceeding
An adversary proceeding is a separate lawsuit within the bankruptcy case, specifically aimed at determining the dischargeability of your student loans. It's usually required because student loans are not automatically discharged in a standard bankruptcy filing.
The timeline for an adversary proceeding can vary, but it generally takes several months from start to finish. The outcomes can differ, ranging from a complete discharge of your loans to partial relief or even outright denial. Remember that this process comes with its own set of costs, including court and attorney fees.
How Courts Assess Undue Hardship in Student Loan Bankruptcy
Courts use various criteria to assess undue hardship, and the standards can differ depending on the jurisdiction. The two most widely used tests are the Brunner test and the Totality test.
The Brunner test is a legal standard often used to determine if paying back your student loans would constitute undue hardship. This precedent originated from Brunner v. New York State Higher Education Services Corp. To satisfy the test, you need to prove:
Below-Minimum Standard of Living
Would repaying your student loans prevent you from maintaining a minimal standard of living? This doesn't mean luxury — it refers to fundamental needs like housing, food, health care and essential utilities. Courts will examine your income and expenses to determine if loan repayment would push you below this threshold.
Will your financial strain last for a considerable amount of your loan payback period? Temporary setbacks may not suffice. The court needs evidence of the longevity of your financial strain.
Good Faith Efforts
Have you made genuine attempts to repay the loan? Courts will examine your payment history, attempts at negotiation with the lender and exploration of income-driven repayment plans. A lack of effort can be detrimental to your case.
The Totality test (short for “totality of circumstances”) offers a more holistic approach to evaluating undue hardship. This test considers your current and future financial situation, including income, expenses and prospects. Specifically, it looks at three main elements:
Financial Resources Assessment
This goes beyond your current income and includes an evaluation of your potential future earnings. Courts will assess your career trajectory and any opportunities for financial growth.
Living Expense Calculation
This test scrutinizes all your expenses (not just the essentials) to understand your financial obligations fully.
Relevant Factors Consideration
This catchall category can include a variety of factors — from your health and age to family responsibilities — offering a more nuanced understanding of hardship.
Consequences of Filing for Bankruptcy
Filing for bankruptcy can be a lifeline if your student loan debt is unmanageable, but it's not a decision to be made lightly. Filing has long-term consequences for your financial standing and emotional well-being, including those outlined below.
Impact on Credit Score
A bankruptcy filing can drastically lower your credit score, sometimes by 200 points or more. This can take years to recover, making securing any credit more difficult and expensive.
Some employers view a bankruptcy filing as a red flag, which could affect your chances during job applications. In some industries, it might even hinder your ability to get promotions or move up the career ladder.
In certain types of bankruptcy, you may be required to liquidate assets like your home or car to repay creditors. This can be a devastating loss and should be carefully considered.
After bankruptcy, you'll find getting approved for loans or credit cards challenging. When you are approved, you'll likely face much higher interest rates.
Social and Emotional Impact
The stigma associated with bankruptcy can be emotionally draining. It can also strain personal relationships, as financial instability can be a significant source of stress.
Bankruptcy laws restrict how often you can file. For example, you must wait at least eight years after a Chapter 7 discharge to file for Chapter 7 again. This can limit your financial options in the future.
Alternatives to Filing Bankruptcy for Student Loans
Bankruptcy isn't the only route for tackling student loan debt. Consider options like income-driven repayment plans and student loan forgiveness programs. These alternatives can offer financial relief without the long-term consequences of bankruptcy.
Deferment or Forbearance
Deferment and forbearance allow you to pause your student loan payments temporarily. Deferment is often used for federal loans and lasts up to three years. Forbearance is more common with private loans and usually lasts for 12 months. To qualify for deferment, you may need to be enrolled in school, unemployed or facing financial hardship. For forbearance, the criteria can vary by lender but often include financial difficulties or medical expenses.
"With federal loans, if you file for a general forbearance, you can renew the 12-month term every year for up to three years — but you need to apply for it directly." — Daniel Cieniewicz, CFP®
- Immediate Relief: Provides immediate financial relief, easing your current financial burden.
- Credit Score: No negative impact on your credit score during the deferment or forbearance period.
- Accruing Interest: Interest may continue to accrue, increasing the total loan amount you owe.
- Short-Term: This is a temporary fix and not a valid long-term solution for loan repayment.
Income-Driven Repayment Plans
Income-driven repayment plans adjust your monthly student loan payments based on income and family size. These plans are primarily available for federal loans and come in various types, including the Income-Based Repayment (IBR) Plan, SAVE Plan and Pay As You Earn (PAYE) Plan.
- Manageable Payments: Makes monthly payments more manageable based on your financial situation.
- Loan Forgiveness: Offers the possibility of loan forgiveness after a certain number of payments.
- Extended Term: May extend the loan term, leading to more interest payments over time.
- Annual Recertification: Requires yearly recertification of your income and family size.
Loan Forgiveness Programs
Loan forgiveness programs offer a way to eliminate a portion or even all of your student loan debt. These programs are often tied to specific career paths or public service commitments. Notable programs include Public Service Loan Forgiveness (PSLF) for those in government or nonprofit sectors and Teacher Loan Forgiveness for educators in low-income schools.
- Debt Relief: The most apparent benefit is the potential for significant debt relief, sometimes up to 100% of your remaining loan balance.
- Career Incentives: These programs often align with careers in public service or high-need areas, providing an additional incentive to enter these fields.
- Tax Benefits: Some programs offer tax-free loan forgiveness, meaning you won't be hit with a large tax bill when your debt is forgiven.
- Strict Eligibility: The criteria can be stringent, requiring years of service in specific job roles or locations.
- Limited Scope: Not all types of loans or loan servicers may be eligible for forgiveness programs.
- Long Commitment: Programs like PSLF require a long-term commitment, which might not suit everyone's career or life plans.
Loan Refinancing Options
Loan refinancing involves taking out a new loan to pay off one or more existing loans, often to secure better terms, such as a lower interest rate or a different repayment schedule. Refinancing can be wise if you have a strong credit score, stable income or interest rates have dropped since you first took out your loans.
- Lower Interest Rates: One of the biggest draws is the potential for a lower interest rate, which can save you thousands over the life of the loan.
- Flexible Terms: Refinancing can offer more flexible repayment terms, allowing you to choose a schedule that better suits your financial situation.
- Single Payment: If you're refinancing multiple loans, consolidating them into one payment can simplify your finances.
- Loss of Benefits: Federal loans come with certain protections like income-driven repayment plans and loan forgiveness options, which you'll lose if you refinance.
- Costs and Fees: There may be origination fees or other costs associated with refinancing.
- Credit Impact: Applying for a new loan will result in a hard credit inquiry, which could temporarily lower your credit score.
Loan consolidation is the process of combining multiple loans into a single loan with one monthly payment. This can be particularly beneficial if you have several federal student loans, as it simplifies your payment schedule and can offer access to alternative repayment plans.
- Simplified Payments: One of the most immediate benefits is the convenience of a single monthly payment.
- Access to Different Repayment Plans: Consolidating federal loans can make you eligible for income-driven repayment plans you might not have qualified for otherwise.
- Fixed Interest Rate: A consolidated loan offers a fixed interest rate, calculated as the weighted average of the rates on the loans being consolidated.
- Loss of Borrower Benefits: Some loans have borrower benefits that will be lost upon consolidation, such as interest rate discounts.
- Longer Repayment Period: While smaller monthly payments might be appealing, they often come at the cost of a longer repayment period, which can mean more interest paid over time.
- Upfront Costs: Some private lenders may charge fees for loan consolidation.
Total and Permanent Disability Discharge
If you're dealing with a physical or mental impairment, you may qualify for an automatic discharge of your student loans under the Total and Permanent Disability Discharge (TPD) program. This program is designed to reduce the financial burden of those unable to work due to a severe condition.
- Provide Necessary Documentation: You must provide medical evidence confirming your total and permanent disability. This can be a physician's certification or documentation from the Social Security Administration or the U.S. Department of Veterans Affairs.
- Submit Your Application: Submit the TPD Discharge application form, which is available on the Federal Student Aid website. Ensure all required documents are attached.
- Wait for the Review Process: Once submitted, your application will undergo a review process, which can take up to a few months. If approved, your loans will be discharged, and you'll receive a notification.
When to File for Student Loan Bankruptcy
Deciding to file for student loan bankruptcy is a monumental step that should only be taken after exhausting all other avenues. Bankruptcy can offer a way out of student loan debt, but it's generally advisable to consider this route under the following circumstances:
Exhausted Alternative Options
Bankruptcy becomes more viable when you've exhausted all other avenues. If deferment, income-driven repayment plans and loan forgiveness programs have not provided sufficient relief, you may need to consider bankruptcy.
Chronic Unemployment or Underemployment
If you've been consistently unable to secure stable, well-paying employment, bankruptcy could be a way to manage your unpayable debt. This is especially true if your employment prospects are unlikely to improve in the near future.
A severe illness or disability can drastically change your financial landscape. If your medical condition makes it impossible to work and repay your loans, bankruptcy could be a way to discharge or restructure your debt.
If you're approaching retirement age and still have a significant student loan balance, bankruptcy could help you enter this life stage without a debt burden. This is particularly relevant if your retirement savings need to be increased.
Events like divorce or having dependents can strain your finances. If these life changes make loan repayment unmanageable, bankruptcy might be the best course of action to protect your and your family's financial future.
Post-Bankruptcy Financial Planning
Navigating life after bankruptcy requires having a comprehensive financial strategy. From rebuilding your credit to understanding legal limitations, the road ahead is filled with important decisions.
Bankruptcy can severely impact your credit score, but strategic steps like obtaining secured credit cards and making timely payments can help you improve your score. Here are steps to help you boost your credit score.
Monitor Your Credit
Regularly reviewing your credit report can help you track your progress and allow you to catch any errors that could hinder your credit-rebuilding efforts.
Utilize Secured Credit Cards
These are often the go-to options for individuals looking to rebuild credit. A secured credit card requires a cash deposit, which serves as your credit limit, minimizing the lender's risk while allowing you to demonstrate responsible credit use.
Make Timely Payments
Making all your payments on time across all credit accounts can significantly improve your credit score. Consistency is key. According to Experian, payment history accounts for 35% of your FICO Score.
Setting New Financial Goals
Emerging from bankruptcy offers a clean slate to reset your financial priorities. Setting achievable goals can guide you toward long-term stability.
Build an Emergency Fund
An emergency fund is your financial safety net. Post-bankruptcy, it's crucial to start building an emergency fund to cover unexpected expenses like medical emergencies or job loss. Aim to save for at least three to six months of living expenses.
Utilize a Debt Repayment Strategy
If you still have debts post-bankruptcy, create a debt repayment plan. Prioritize high-interest debts and consider debt consolidation options if applicable.
Budgeting and Expense Management
Effective budgeting is crucial for maintaining financial health post-bankruptcy. A well-planned budget can help you avoid falling back into debt.
Create a Budget
A thoughtful budget can act as a roadmap to financial stability. It helps you track income and expenses, making it easier to make informed financial decisions.
Cut Unnecessary Expenses
Review your spending patterns. Determine where you may save money, such as limiting dining out or canceling subscription services you rarely use.
Consider Additional Income Streams
Don't rely on a single source of income. Consider freelancing, wokring a part-time job or investing to diversify your income and enhance your financial resilience.
Navigating the legal landscape post-bankruptcy is crucial, as it impacts your credit and future loan opportunities. Be mindful of legal restrictions and the long-lasting imprint of a bankruptcy record.
Learn About Your Bankruptcy Record
A bankruptcy filing can stay on your credit report for up to 10 years, affecting your ability to secure loans or credit. However, its impact diminishes over time, especially if you practice good financial habits.
Be Aware of Legal Restrictions
Post-bankruptcy, you may face limitations like higher interest rates on loans and difficulty securing large amounts of credit. Be aware of these restrictions as you plan your financial future.
Tackling student loan debt can be daunting, but help is available. Below are curated resources to guide you through the process.
- American Consumer Credit Counseling: Provides free consultations and affordable services to help manage and reduce debt.
- Consumer Financial Protection Bureau (CFPB): Provides information and resources to help you make informed financial decisions, including those about student loans.
- Edvisors: Provides in-depth information, advice and tools to help students plan and pay for college, including managing student loans.
- Federal Student Aid: U.S. Department of Education's hub for all federal student aid information.
- FinAid: A comprehensive source for student financial aid information, advice and tools.
- National Association of Consumer Advocates: Association of attorneys and advocates focusing on consumer issues, including student loans.
- National Consumer Law Center: Provides legal expertise to promote consumer rights, including those related to student loans.
- National Foundation for Credit Counseling: Offers financial education and certified counseling services, including for student loans.
- Student Borrower Protection Center: Advocacy group focused on alleviating student debt and influencing policy.
- Student Debt Relief: Offers information on student loan forgiveness programs, laws and other ways to manage student debt.
- Student Loan Planner: Offers consulting services and hosts a blog with free information on how to tackle student loan debt.
- The College Investor: Focuses on helping students get out of student loan debt and start investing for their future.
- The Institute of Student Loan Advisors: Offers free expert advice and affordable services for managing student loans.
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- Consumer Financial Protection Bureau. "I filed for bankruptcy. How long will that appear on credit reports?." Accessed October 23, 2023.
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- Federal Student Aid. "Income-Driven Repayment Plan." Accessed October 23, 2023.
- Federal Student Aid. "Pay As You Earn (PAYE) Plan." Accessed October 23, 2023.
- Federal Student Aid. "Public Service Loan Forgiveness (PSLF)." Accessed October 23, 2023.
- Federal Student Aid. "Saving on a Valuable Education (SAVE) Plan." Accessed October 23, 2023.
- Federal Student Aid. "Teacher Loan Forgiveness." Accessed October 23, 2023.
- Federal Student Aid. "Total and Permanent Disability (TPD) Discharge." Accessed October 23, 2023.
- Federal Student Aid. "What are loan deferment and forbearance?." Accessed October 23, 2023.
- Office of Public Affairs. "Justice Department and Department of Education Announce a Fairer and More Accessible Bankruptcy Discharge Process for Student Loan Borrowers." Accessed October 23, 2023.
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- United States Bankruptcy Courts. "Bankruptcy Case Vs. Adversary Proceeding, What Is The Difference?." Accessed October 23, 2023.
- United States Courts. "Chapter 13 - Bankruptcy Basics." Accessed October 23, 2023.
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