Bankruptcy Law

Bankruptcy and Student Loan Debt: What You Need to Know

Americans currently owe over $1 trillion on their federal student loans, and that figure is ever rising. Those carrying student loan debt on average owe more than $45,000 and over five million federal loan borrowers currently find themselves in default.

As the student loan crisis worsens, many borrowers are wondering what effect bankruptcy may have on their debt, if any. Here's what you need to know about student loan relief and your options.

Discharging Student Loan Debt in Bankruptcy

The conventional wisdom for years was that, while bankruptcy might clear out your credit card and mortgage or auto loan debt, there wasn't much you could do about student loans. Public student loans -- those backed by the federal government -- were always nearly impossible to discharge, and a recent 2005 law exempted all student loans from discharge in bankruptcy unless the borrower could demonstrate "undue hardship."

That has proven to be a high bar for borrowers to meet, but not an impossible one. 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
  • 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
  • Physical or mental impairments that negatively impact your earning potential, especially if you receive Social Security or disability benefits

In any case, student debt discharge is not an automatic part of a bankruptcy filing. You will need to request relief from your student loan debt and make the case that continued repayment would constitute an undue hardship.

Student Loan Repayment Options

As noted above, a good faith effort to repay your student loans is a key factor in determining whether bankruptcy will discharge your debt. So, if you're trying to avoid filing for bankruptcy, increase your chances of discharge, or if you were denied a discharge and must continue repayment on your student loans, you might be wondering what options you have.

The specifics of any repayment plan will depend on the source of your loan, the lender, and whichever financial company may be handling your repayment. Most lenders, however, offer similar repayment options:

  • Standard Repayment: Monthly payments are consistent, and determined by the loan amount and the payoff period, generally 10 years.
  • Graduated Repayment: Monthly payments may be lesser at the beginning and increase every two or three years, usually with the same 10-year payoff period.
  • Income-Based Repayment: Monthly payments are determined based on your annual income, or joint income if you are married.

Although standard repayment plans may appear expensive at first, they could save you money in the long run by shortening the time it takes to pay off the debt and reducing the interest accrued in the meantime. While income-based repayment may mean your monthly payments could be as little as zero, the debt will remain and interest will continue to accrue until the full balance is paid off.

Keep in mind that your student loans may be eligible for consolidation or refinancing that 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 are unable to make your monthly payments for certain reasons. Borrowers should know about the general differences between deferment, under which the lender may suspend interest accrual or make interest payments for you, and forbearance, under which interest continues to accumulate.

What Happens If You Default on Your Student Loans?

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. Usually, the first thing that will happen is the Department of Education or your lender will seize your tax refund, if you're eligible for one. The IRS can automatically take your federal or state refund to repay defaulted student loans.

Lenders may also be allowed to garnish your wages. While statutes may limit how much lenders can take out of your weekly income, they need not obtain a court judgment prior to wage garnishment. In addition, government agencies can reduce or set aside income in the form of Social Security retirement and disability benefits to repay loan debt.

In some states, professional or vocational licensing boards, like those that govern attorneys, teachers, and medical professionals, may revoke licenses if you have defaulted 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 file a lawsuit against you to collect the outstanding student loan debt. Borrowers should be aware that there is no applicable statute of limitations on these kinds of lawsuits, 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. So, if you're facing mounting student loan debt and don't see a way out, contact an experienced bankruptcy attorney in your area to discuss your options.

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