Bankruptcy is rarely an easy process, but it’s notoriously difficult with student loan debt. Though it is possible to discharge either federal or private student loans through bankruptcy, you have to prove undue hardship to do so.
About 4 out of 10 Americans who filed for bankruptcy were able to have their student loans discharged, yet only 0.1% of student loan borrowers have even attempted to do so, according to a recent study by the American Bankruptcy Law Journal. If you’re successful, your outstanding student loan debt may be partially or fully discharged. However, it doesn’t always work. Here’s what you need to know before going down this path.
It is possible to discharge student loan debt through bankruptcy, but you’ll have to go through a difficult process to do so. To discharge your student loan debt through bankruptcy, you have to prove that you can’t pay back your student loans without it having an extremely negative impact on you and your dependents.
Courts are left with some room to interpret your eligibility. Most, but not all, federal courts of appeal evaluate hardship using a set of standards known as the Brunner Test, which was established as the result of a 1987 federal court ruling, Marie Brunner v. New York State Higher Education Services Corp.
The factors of the Brunner test are outlined by the U.S. Department of Education’s Federal Student Aid office and include three main points:
- You wouldn’t be able to maintain a basic standard of living if you had to pay back your federal student loans.
- You can prove that the hardship will last for a substantial portion of your repayment period.
- You honestly tried to repay your federal student loans before this point.
Other courts, namely the 1st U.S. Circuit Court of Appeals and the 8th U.S. Circuit Court of Appeals, rely on a different standard, known as the “totality of circumstances,” which considers your past, present and future financial resources; reasonable living expenses; and other relevant factors related to bankruptcy proceedings.
Recently, there has been some movement in Washington, D.C. to provide some clarity to the qualifications to discharge student debt through bankruptcy. Since it is up to each bankruptcy court to interpret the standards, the results can vary. Last spring, the Department of Education released a request for public comment on factors for evaluating undue hardship and whether the existence of two sets of standards results in inequality for borrowers seeking to discharge their student loan debt.
In Congress, proposed legislation, H.R. 5549, or the Higher Ed Act, proposes expanding the definition of undue hardship, which could help more borrowers qualify for discharged or reduced student loan bills. Currently, it is up to courts to determine what qualifies for undue hardship and there is no federal standard.
Proving undue hardship in student loan bankruptcy
For now, the burden is on borrowers to establish their qualifications for undue hardship that satisfy the court they’re in front of. While it might seem easy to prove financial dire straits, that isn’t always the case, according to Michael Fuller, a bankruptcy attorney.
“You have to be in a somewhat extreme situation,” Fuller said. “It is often people who are sick, people who are on disability or people who have an extreme financial situation that is not going to improve.”
For instance, Fuller said he recently worked pro bono with a single mother of four kids who owed several hundred thousand dollars on student loans. While she was employed, the woman was unable to make payments on her loans. Through bankruptcy, Fuller was able to demonstrate the debt caused undue hardship for her and her dependents and had her outstanding loans discharged.
How student loan bankruptcy discharge works
1. Understand your situation
If you are determined to try to erase your student loan debt through bankruptcy, you’ll have to follow a very specific procedure. It is important to have all of your loan documents and personal financial paperwork in order. You need to be organized if you hope to successfully make your case.
When it comes to bankruptcy, it doesn’t make a difference if your loans are federal or private.
2. Consider hiring a lawyer
While you don’t technically have to go through a lawyer to file for bankruptcy, student loan bankruptcy can be an incredibly complex process. It requires determining which type of bankruptcy you’ll file for and submitting an extra lawsuit, called an adversary proceeding (more on that later). Going through it all alone could mean extra time, incorrect filings and, possibly, a lost case.
However, one thing to consider is that hiring a lawyer could actually hurt your chances for discharging your student loans in bankruptcy, according to Fuller. That’s because some judges may feel that if you can afford fees for an attorney, then you can afford to be paying back something on your loans, which would disqualify you from experiencing undue hardship.
If you don’t know a lawyer, don’t worry. You can find one through the American Bar Association. You might be eligible for a lawyer at no cost to you (also known as pro bono) through the Legal Services Corporation, an independent nonprofit created by Congress that offers financial support for civil legal aid to low-income Americans. Just make sure you pick a lawyer that specializes in bankruptcy and has very good reviews.
If you opt to handle your case yourself, a recent study by the American Bankruptcy Journal noted that debtors without a lawyer were just as likely to have their student loans discharged by a bankruptcy judge as those who worked with an attorney.
3. File for an adversary proceeding
Whether you hire a lawyer or go it alone, you’ll need to file for an adversary proceeding, which is a hearing to determine the possibility of discharging your student loan debt. You’ll have a hearing in bankruptcy court and your creditors are required to be present. At that hearing, you’ll need to provide evidence that you qualify for undue hardship standards.
This is part of the process that is unique to bankruptcy and student loans. Note that you can’t proceed with a student loan bankruptcy without this step.
4. Decide which type of bankruptcy to file for
Next, on your own or with your lawyer, you’ll need to decide whether to file for Chapter 7 or Chapter 13 bankruptcy. Student loan bankruptcy can be addressed under either Chapter 7 or Chapter 13 bankruptcy, though it’s treated differently under the two categories.
Below is a breakdown of some of the qualifications and how each type of bankruptcy treats student loan debt:
Chapter 7 bankruptcy
- You must prove you have little disposable income available to pay off your debt.
- Most unsecured debt can get wiped out.
- Student loan debt may be eligible for discharge.
- The process can take about four months.
Chapter 13 bankruptcy
- You have some income to use to repay some of your debts.
- Your debt will be restructured, and some of it will need to be repaid.
- Student loan debt may be eligible — but your repayment will be restructured, not discharged.
- The court process can last from two to six months, and the repayment plan can take three to five years.
Note that personal bankruptcy can come at the cost of hurting your credit for years. When it comes to your credit report, a Chapter 7 bankruptcy remains there for 10 years, while a Chapter 13 bankruptcy stays for seven years, which can make it difficult for you to secure loans or credit, as well as favorable rates. When you file for bankruptcy, you can also rack up significant legal and court fees along the way.
That said, if you’re defaulting on debt, then your credit score has already taken a hit. Also, if you are successful in filing for bankruptcy protection, your student loan servicer won’t be able to garnish your wages. So at this point, bankruptcy may, in fact, provide you with a fresh start.
5. Get an outcome
If you successfully prove undue hardship, your loans could be fully discharged, partially discharged or restructured.
With a full discharge, you will not have to make any more payments on your student loans.If only a portion of your loans are discharged, you’ll be responsible for paying the remainder. On the other hand, if your loans are restructured, you may be required to repay your loan but you’ll receive new repayment terms that should be easier for you to handle, including a lower interest rate.
Can you file bankruptcy on student loans? Maybe. Should you? That depends on your personal situation.
Bankruptcy is a complicated, intrusive and extensive process. In fact, Fuller advises not doing it at all if you can. “It should be a last resort,” he said.
There are many alternative solutions to bankruptcy. For example, federal student loans come with options such as income-driven repayment plans and deferment or forbearance. These programs could provide relief without the extreme step of bankruptcy.
You also have the option to apply for forgiveness, either through an income-driven repayment plan or Public Service Loan Forgiveness (PSLF). PSLF is available to those who work for certain public service organizations, such as government agencies or nonprofits.
And if you have private student loans, talk to your lender. They might have a hardship program that you didn’t know about. Fuller suggests sending to your private loan servicer a letter via certified mail outlining your financial hardships, your income and how much you’re able to pay. (Remember to keep a copy.) Your servicer may respond with a repayment plan that provides some relief. After all, you don’t lose anything by asking.
Before declaring bankruptcy and trying to fight against a system that makes it difficult to discharge your student loan debt, be sure to research your other debt repayment options for student debt relief.
Alli Romano contributed to this report.