Bankruptcy Law

What Happens to Student Loans in Bankruptcy Cases?

Key Takeaways:

  • Unlike other kinds of debt, most student loan debt can’t be forgiven in bankruptcy.
  • If you file bankruptcy, you must demonstrate that student loan repayment would cause undue hardship.
  • The undue hardship standard is high, and the bankruptcy court may consider several factors, including any repayment efforts.

Student debt is high, and many graduates feel the effects. Borrowers had to deal with the financial impacts of the COVID-19 pandemic when companies closed, laid off employees, and stopped hiring. Unfortunately, unlike other kinds of debt, most student loan debt can’t be forgiven in bankruptcy.

If you use bankruptcy to get out from other debts, like credit card debt, medical bills, or car loans, it is essential to understand that student debt may remain even after the other debt is eliminated. There are some exceptions, but they are rare. Bankruptcy law questions about your financial situation can be answered by a local bankruptcy attorney.

How Are Student Loans Treated in Bankruptcy?

Under the bankruptcy code, most secured debts and unsecured debts can be discharged at the end of Chapter 7 bankruptcy proceedings. However, certain debts are non-dischargeable, including child support payments, alimony, and student loan debt. Starting in 1976, Congress made educational loans non-dischargeable for five years.

In bankruptcy, federal student loans are exempted from discharge if:

  • It was made, insured, or guaranteed by the government, or
  • It was made under any loan program funded in whole or in part by the government or nonprofit institution.

However, there are limited exceptions when private student loans can be discharged. According to the U.S. Department of Education, bankruptcy discharge is not automatic.

When Can Student Loans Be Discharged in Bankruptcy?

If you file bankruptcy, you must demonstrate that the repayment plan would cause undue hardship. You have to present your case in an adversary proceeding in bankruptcy court with your creditors, including student loan servicers.

The goal of this is to show that you have been put into a position where you consider your loans to be impossible to repay, defining them as an undue hardship. In essence, it is to show that extreme circumstances out of your control have made you unable to repay student loans. You are asking the bankruptcy judge to include student loans with other types of debt.

The undue hardship standard is high. The bankruptcy court may consider several factors under what’s known as the “Brunner Test,” including:

  • Under the repayment options, you cannot maintain a minimal standard of living
  • There is evidence the hardship will continue for a significant portion of the student loan repayment period
  • You have made good-faith efforts to repay the lender

You may have a different definition of a minimal standard of living, but the court will generally consider your income, expenses, assets, and options. It is not the same as a comfortable living or the living you had before filing for bankruptcy. You are also supposed to maximize income and minimize expenses.

Minimal standards generally mean necessities like food, clothing, shelter, medical care, and transportation. The court may claim you can get a cheaper cell phone plan, cut off cable, or stop eating out. The court generally considers money spent on travel, entertainment, or recreation as unnecessary.

Maximizing income may mean the court thinks you should have applied for better jobs given your education and qualifications.

A good faith effort can include making some amount of monthly payment every month or applying additional money toward the debt when it is available.

How Much of the Student Loans Can Be Forgiven in Bankruptcy?

If the court finds the loans present an undue hardship, they can discharge some or all of your loan debt. The court’s options include:

  • Fully discharge student loans (no more repayments or debt collection on student loan debt)
  • Partial discharge (requiring repayment of the remaining portion of your federal loan)
  • Repay your loans but with modified repayment terms (such as a lower interest rate)

Are There Alternatives to Bankruptcy for Student Loan Debt?

Borrowers who can’t qualify for bankruptcy may be able to get a student loan forbearance, which is a temporary pause on making payments or temporarily lowering the monthly loan payments. Unfortunately, forbearance is only temporary debt relief, and it won’t help you make much progress in paying down your loan.

Another alternative is an income-driven repayment plan. An income-driven repayment plan bases your monthly payments on income and dependents. You can get loan forgiveness after 20 or 25 years. Talk to your lender as soon as possible if you are having trouble making payments.

Are There Other Student Loan Bankruptcy Options?

According to the Federal Reserve, most student loan borrowers owe less than $25,000 on student loan payments. However, about 25% of borrowers owe more than $50,000. If you’re waiting for other options, they may be a long time coming.

If you think a student loan bankruptcy may be your best option, contact a bankruptcy attorney for advice.

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