Here’s What Really Happens to Student Loans When You File Bankruptcy

bankruptcy and student loans

Get ready to reconsider everything you think you know about bankruptcy and student loans.

Whether you’re hoping it will wipe them out, or you know better than to entertain such a pipe dream, the truth is this: Bankruptcy does not automatically discharge student loans, but it’s also not as far-fetched of a possibility as you may have been led to believe.

The simplest way to understand bankruptcy and student loans is to examine the two types of bankruptcy you may file.

Chapter 13 bankruptcy and student loans

Chapter 13 bankruptcy is a reorganization in which no debts are automatically discharged. Instead, you enter into a repayment plan to pay back a portion of your debts (of which your student loans may be included).

1. Upon filing your Chapter 13 bankruptcy petition, an automatic stay is granted. This prohibits most creditors – including student loan servicers – from trying to collect on your debts. This protection continues throughout the duration of the case, as well as your repayment period (if granted).

2. Under Chapter 13 bankruptcy, your student loans are considered “nonpriority unsecured debt.” This means you are not required to pay the full amount of your student loans through the Chapter 13 repayment plan.

3. The amount you end up paying toward your student loans in Chapter 13 bankruptcy can vary. It depends on your overall repayment plan; your student loans receive a pro rata share, which will likely represent a dollar amount less than your regular monthly student loan payment. In some cases, your student loan debt might be discharged.

4. If you want to continue making full monthly payments on your student loans during Chapter 13 bankruptcy, you might not be allowed to do so. While some jurisdictions allow it, others do not, as it reduces what you have to pay toward other high-priority debts.

5. Your student loans continue to accrue interest throughout the Chapter 13 repayment plan, which may be three to five years.

6. Once the repayment plan is over, you are responsible for the remainder of your student loans.

Chapter 7 bankruptcy and student loans

Chapter 7 bankruptcy results in a liquidation of your assets. Unlike Chapter 13, there is no repayment plan. Some debts are fully discharged, others are not.

1. Upon filing your Chapter 11 bankruptcy petition, an automatic stay is granted, which prohibits most creditors – including student loan servicers – from trying to collect on your debts.

2. Under Chapter 7 bankruptcy, your student loans are not automatically discharged.

3. To have your student loans considered for discharge, you can file a Complaint to Determine Dischargeability, which initiates what’s known as an adversary proceeding.

4.  It may not be as hard to discharge student loans as you have been led to believe. In the case of extreme financial hardship that results in having very little to contribute toward the repayment of your debts overall, the court may decide to discharge your student loans completely.

The process is quite difficult and rarely happens, but it is possible. According to a study published in 2011, 40 percent of those who initiated the adversary proceeding were able to discharge all or part of their student loans.

However, only 0.1 percent of those who file Chapter 7 petitions filed the Complaint to Determine Dischargeability. In other words, people are so convinced it’s a near-impossibility that they don’t even bother trying.

“You see more and more judges siding with debtors for humane reasons,” Richard Fossey, a professor at the University of Louisiana who studies bankruptcy cases, told Yes Magazine. “It’s [judges] who are setting a trend with their decisions.”

5. However, your student loan holder may oppose your undue hardship claim. A July 2015 letter from the U.S. Department of Education advises loan holders on how this determination is made:

“First, a holder must evaluate a borrower’s undue hardship claim and determine whether the holder believes that repayment would constitute an undue hardship according to the legal standards set by the federal courts.”

If the loan holder believes you’ve proven undue hardship, they may not oppose.

If the loan holder does not believe you have proven undue hardship, they may oppose, but not before running the numbers on just how much such an opposition will cost. If it’s more than a third of what you owe, the loan holder may not oppose.

6. The court uses one of two tests to determine undue hardship, the criteria for which are outlined in the Department of Education letter referenced above.

Under the Brunner test, you must show that:

  • Paying back your student loans will make it impossible for you to maintain a “minimal” standard of living
  • Your financial situation is not likely to change anytime soon
  • You’ve made a “good faith effort” to pay back your student loans up to this point

Under the Totality of the Circumstances test, the court considers:

  • Your past, present, and likely future financial resources
  • Reasonably necessary living expenses
  • Other relevant facts and circumstances

While these are the two most common tests, some courts use others. A bankruptcy attorney should be able to tell you which test is used in your jurisdiction.

7. If the court finds that you have, indeed, proven undue hardship, you may have all or a portion of your student loans discharged.

8. If the court finds that you have not proven undue hardship, your student loans will not be discharged and you will be responsible for paying them back in full.

Before you file bankruptcy

Bankruptcy should be treated as a last resort under any circumstance. So, before filing bankruptcy on student loans, make sure you have exhausted every other possibility. This is especially important if you have federal student loans, as you have numerous income-driven repayment plan options, such as REPAYE and IBR.

Also, keep in mind that the information provided here on bankruptcy and student loans is not intended to replace legal advice. For recommendations specific to you, consult with a bankruptcy attorney.

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