Bankruptcy and Student Loan Debt: What You Need To Know
- To discharge student loan debt in bankruptcy, you have to meet the undue hardship standard, which is difficult.
- Alternatives to bankruptcy include debt consolidation and income-based repayment plans.
- Even if you can't erase student loan debt, bankruptcy can still discharge credit card, personal loan, and medical debts.
Millions of Americans are trying to figure out how to pay down their student loan debt while dealing with inflation, high costs of living, increasing housing costs, and expensive medical insurance premiums. When you are deep in debt, bankruptcy is your best chance for debt relief. Unfortunately, bankruptcy may not help get rid of federal student loan debt.
Even if bankruptcy discharge doesn’t work for you, there may be other alternatives to help reduce your student loan burden. If you have questions about bankruptcy and student loan forgiveness, talk to an attorney about your financial situation.
More than 45 million student loan borrowers in the United States owe more than $1.6 trillion in student loan debt, including both federal loans and private student loans.
According to the Federal Reserve, in 2021, most student loan borrowers had between $20,000 and $25,000 in debt on their loans. However, 25% of student loan borrowers owe more than $50,000, with 10% of borrowers owing more than $100,000.
The conventional wisdom for years was that, while bankruptcy might clear out your credit card debt, there was little you could do about student loans. Public student loans backed by the federal government were always nearly impossible to discharge.
Changes to the bankruptcy code in 2005 made student loan discharge even more difficult, where student loan bankruptcy was only allowed if a borrower could demonstrate “undue hardship.”
Undue hardship is a high bar to meet. Under the “Brunner test,” bankruptcy courts will consider a variety of factors when determining if student loan debt constitutes an undue hardship:
- You made good-faith efforts to repay the loans
- You could not maintain a minimal standard of living for yourself and your dependents if forced to repay the student loans
- There is evidence that your current financial situation is likely to persist for a significant portion of the repayment period of the student loans
- Repayment could keep you trapped in a “cycle of poverty”
- You went to a fraudulent school or legitimately did not benefit from the education you received
- You suffer from physical or mental impairments that negatively affect your earning potential, especially if you receive Social Security or other disability benefits
In any case, student debt discharge is not an automatic part of a bankruptcy case. You must request relief from your student loan debt in what’s known as an adversary proceeding. You have to make the case that your situation meets the criteria of the test listed above. Even if the bankruptcy judge doesn’t give you a full discharge, you may be able to get a partial discharge to reduce your overall debt.
A good faith effort to repay your student loans is essential in determining student loan discharge. Any repayment plan will depend on the source of your loan, the loan servicer, and the financial company processing your payments. Most lenders offer similar repayment options:
- Standard repayment: Monthly payments based on the loan amount, interest rate, and payoff period
- Graduated repayment: Monthly payments start lower and increase every two or three years
- Income-driven repayment plan: Monthly payments are based on your annual income, or joint income if you are married
Standard repayment plans may appear expensive initially but could save you money by shortening the time to pay off the debt and reducing the interest accrued. Income-based repayment may mean your monthly payments could be as little as zero, but the debt will remain and interest will continue to accrue.
Keep in mind that your student loans may be eligible for consolidation or refinancing, which could reduce your monthly payments. However, refinancing may extend your payment period and cost you more in interest payments over the long term.
Additionally, almost all lenders offer periods of forbearance or deferment if you cannot make your monthly payments for certain reasons. With deferrals, the lender may suspend interest accrual or make interest payments for you. Under a forbearance, the interest continues to accumulate.
If you miss a scheduled student loan payment, you are considered delinquent. Miss too many payments in a row and your loan could go into default. The first thing that will happen when you are in default is the U.S. Department of Education or your lender will seize your tax refund. The IRS can automatically take your federal or state refund to repay defaulted student loans.
Lenders may also garnish your wages. State or federal laws may limit how much lenders can take out of your weekly income. In addition, government agencies can reduce or set aside income (from Social Security retirement or disability benefits) to repay loan debt.
In some states, professional or vocational licensing boards can revoke your license if you default on your student loan debt. This could make it even harder to work to repay your debt.
Finally, student loan lenders, including the Department of Education, can sue you to collect the money you owe. There is no applicable statute of limitations on this type of lawsuit, so lenders can file them at any time, even years after default.
Challenging wage garnishment, refund seizure, or license revocation is not easy. Neither is proving undue hardship in bankruptcy court. Even if you can’t meet the undue hardship standard, filing bankruptcy could clear away other types of debt, including credit cards, private loans, and other unsecured debt.
So if you’re facing mounting student loan debt and don’t see a way out, contact an experienced bankruptcy lawyer in your area to discuss your options.
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