Bankruptcy and Student Loans, Explained
If your bills are piling up, you might be considering bankruptcy. But can you declare bankruptcy on student loans? While it has been technically possible for bankruptcy to clear student loans, it was difficult and rare. But in 2022 the Biden administration created a streamlined process for borrowers with “undue hardship” which allows debtors to navigate the bankruptcy application system easier than previous years.Read on to learn about the key requirements to have student loans released in bankruptcy.
What Is Student Loan Bankruptcy?
There is no targeted “student loan bankruptcy” process, but borrowers sometimes use the term when referring to being released from student loans after filing for bankruptcy. Although it’s possible to be absolved of student loan debt this way, the process has been complex and bankruptcy has serious consequences for your financial future.
If you’re still considering student loan bankruptcy, read on to find out when you can and can’t discharge student loans through bankruptcy, different types of bankruptcy, and the requirements needed to prove “undue hardship.”
Don’t miss our comprehensive Student Loan Forgiveness Guide.
When Can Student Loans Be Discharged Through Bankruptcy?
In bankruptcy, “discharge” is the legal term for clearing or releasing your debts. Student loan discharge requires that the debtor prove to the court that they will suffer from “undue hardship” if forced to repay. Until now, the burden of proof was typically greater for federal student loans than private loans.
The specific qualifications of undue hardship vary by state, but may include:
• You have become physically or mentally disabled.
• You have dependents that you support.
• You have a disabled dependent — such as a spouse or child — who requires 24-hour care.
• You are under- or unemployed, and can show a “foreclosure of job prospects” in your industry.
• You have made a good-faith effort to repay your loans over time.
• You have previously attempted to address your student loans through deferment or other protections.
• Your disposable income is not used for nonessential purchases, such as restaurant meals, brand-name clothes, and vacations.
• Your situation is unlikely to improve in the future.
When Can’t Student Loans Be Discharged Through Bankruptcy?
Historically, it has been extremely difficult to get out of federal student loans through bankruptcy. If that kind of legal loophole existed, the argument went, there would be nothing to stop people from completing college or grad school and then immediately declaring bankruptcy.
However, it will be nigh impossible when:
• The debtor cannot prove any undue hardship from the above list.
• The individual’s only debt is student loans. (In fact, you won’t even be allowed to file for bankruptcy.)
• Someone is a recent grad. Not enough time may have elapsed to prove a history of hardship and a good-faith effort to repay loans.
💡 Quick Tip: Enjoy no hidden fees and special member benefits when you refinance student loans with SoFi.
Changes to the Student Loan Bankruptcy Process
In November 2022, the Department of Justice announced changes to the way student loans are handled in bankruptcy court. Currently, the Department of Education is directed to oppose all attempts to discharge student loan debt, even appealing cases where the court decided in favor of the student loan holder.
Under the new process, debtors will complete a 15-page attestation form confirming that they meet the definition of undue hardship. The bankruptcy judge, under guidance from the Justice Department and Department of Education, will assess the request and make a decision to fully or partially discharge the debt.
Recommendations will be guided by a new set of clearer, fairer, and more practical standards for “undue hardship”:
• Present ability to pay. Meaning the debtor’s expenses equal or exceed their income.
• Future ability to pay. Based on retirement age, disability or chronic injury, protracted unemployment, or similar facts.
• Good faith efforts. Referring to the debtor’s reasonable efforts to earn income, manage expenses, and repay their loan.
Debtors will no longer be disqualified based on not enrolling in income-driven repayment.
Understanding Bankruptcy
Bankruptcy is a way of clearing your debts through the court system. Before granting bankruptcy, the court will sort through an individual’s assets and determine which debts to forgive. Some debts are more difficult to discharge than others, such as taxes, alimony, child support, criminal fines — and student loans.
People looking to discharge student loans are required to file either Chapter 7 or Chapter 13 bankruptcy before taking additional steps. If you file for bankruptcy but lose your student loan case, the rest of the bankruptcy will stand — you can’t undo it.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, sometimes referred to as liquidation bankruptcy, is generally filed as a last resort. In this process, assets of the person filing for bankruptcy are “liquidated,” or sold, by the bankruptcy trustee. Some property is exempt — such as a primary residence and vehicle — but everything else will be unloaded. Generally, people who consider Chapter 7 are those with minimal assets and a lower income.
Recommended: Chapter 7 vs Chapter 13 Bankruptcy: Which Is Best for Loans?
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is sometimes referred to as a “wage earner’s plan.” In this case, people filing bankruptcy can create a repayment plan to pay off their debts. Depending on someone’s financial situation, repayment may take place over three or five years.
Chapter 13 bankruptcy is more suited to individuals with valuable assets or who are earning considerable income. In order to file Chapter 13, total secured and unsecured debts must be $2,750,000 or less.
See the table for the main differences between Chapter 7 and Chapter 13 at a glance.
| Chapter 7 | Chapter 13 | |
|---|---|---|
| Timeframe | Several months | 3 to 5 years |
| Cost | Court filing fees, lawyer fees, plus assets given up | Court filing fees, lawyer fees, plus assets given up |
| Income requirement | Must be below the state median (the national median is about $71K) | Must have enough disposable income to pay down debts over 5 years |
| Credit consequences | Negative impact on credit report for 10 years | Negative impact on credit report for 7 years after discharge |
| Benefits | The court wipes select debts. Collections stopped. | Upon completion of payment plan, remaining balance may be discharged. Foreclosure and collections stopped. |
Private Student Loans and Bankruptcy
In the few cases when a court approved the discharge of student loans, they were likely to be private student loans. Private loans do not have the same protections as federal loans in cases of financial hardship, and so borrowers were more inclined to file for bankruptcy. However, private student loans are still exempt from bankruptcy discharge (much like taxes and child support). A borrower must file a kind of sub-lawsuit to have their student loan documents reviewed by the court.
If you have private student loans, you may be interested in this look at private student loan forgiveness options.
Federal Student Loans and Bankruptcy
Up to now, federal student loans were especially hard to discharge through bankruptcy. Even if you made it that far (and a good student loan attorney would discourage you), the burden of proof was greater for federal student loans than private loans. The new process described above should remedy this situation by helping “ensure transparent and consistent expectations for the discharge of student loan debt in bankruptcy,” according to the Office of Public Affairs for the Department of Justice.
Federal student loans do come with built-in protections for struggling borrowers, like deferment, forbearance, and income-driven repayment plans. These options can provide relief to most borrowers experiencing temporary financial setbacks. See below for details on these programs.
You might also be interested in this deep dive into the differences between federal vs. private student loans.
Filing Bankruptcy on Student Loans
While bankruptcy can provide some relief to individuals who are overwhelmed by immense debts, doing so has serious consequences. Bankruptcy is generally a last resort and can have lasting impact on an individual’s credit score.
A low credit score can make it almost impossible to qualify for credit cards, a mortgage, or a car loan. It can also lower the chances of qualifying for a rental apartment and utilities.
To have a shot at a student loan bankruptcy discharge, an individual must first file for bankruptcy. They must then initiate a separate court filing, known as an “adversary proceeding.” This is essentially a request that the court find that repaying the student loans is an undue hardship to both the individual and their dependents.
Here is a brief overview of the process and its challenges:
Cost of Filing for Bankruptcy
The first step is to file for bankruptcy — likely Chapter 7. The cost of filing is fixed at $338, but the cost of an attorney varies depending on where you live, the attorney’s reputation and experience, and the complexity of your case.
The average cost of an attorney in Chapter 7 bankruptcy is $1,450. Because of the complexity and challenges of getting student loan debt discharged, it’s recommended that you retain a student loan attorney to help you through the process.
If you are filing Chapter 13, the filing fee is $313, and the average attorney fee is $3,000.
Adversary Proceedings
While your bankruptcy case is still open, you’ll need to file a separate but related complaint, which will begin an additional lawsuit known as an “adversary proceeding,” or AP. (Essentially, you’re suing your student loan lender or servicing company.) The court will review the complaint and the circumstances of your undue hardship and make a decision.
There is a $350 AP filing fee, which may be waived in bankruptcy cases.
Undue Hardship
The last step is to prove in your AP lawsuit that repaying your student loans have and will continue to cause undue hardship. While this may feel like an accurate assessment of your situation, proving undue hardship means meeting the specific standards described above.
In the event that the court finds in your favor, there are a few different things that can happen:
• The loans might be fully discharged. This means that the borrower will not need to make any more loan payments. All activity from collections agencies will stop too.
• The loans may be partially discharged. In this case, the borrower will still be required to repay the portion of the debt that is not discharged.
• The loan terms may change. The borrower will still be required to repay the debt, but there will be new terms on the loan, such as a lower interest rate.
Alternatives to Declaring Bankruptcy
Fortunately, there are alternative options to declaring bankruptcy. To help you decide which path to take, you may want to consult with a credit counseling agency or a student loan attorney who can provide more personalized advice.
Note that some of the options below apply to either federal student loans or private student loans, but not both.
Student Loan Deferment and Forbearance
For short-term solutions for federal student loans, consider student loan deferment or forbearance. These options allow borrowers to temporarily pause their loan payments. Unlike declaring bankruptcy, federal student loans in deferment or forbearance generally don’t have a negative effect on your credit.
Additionally, while the debt ceiling bill officially ended the payment pause, requiring interest accrual to resume Sept. 1 and payments to resume Oct 1, borrowers can take advantage of a transitional on-ramp period. The latter will protect borrowers from having a delinquency reported to credit reporting agencies until Sept. 30, 2024.
Income-Driven Repayment Plans
Another option for federal student loans is switching to an income-driven repayment plan, which ties your monthly payments to your discretionary income. If your income is low enough to meet the thresholds for these plans, this could bring payments down significantly — even to $0 — though interest will still continue to accrue.
Special Circumstances
In some cases, someone may qualify for automatic or administrative discharge of your federal student loans. In this case, the borrower isn’t required to appear in bankruptcy court.
Some circumstances that might necessitate an administrative discharge include:
• If the borrower is “totally and permanently disabled.”
• Death of the borrower.
• If the school closed while the borrower was enrolled or shortly thereafter.
• If the borrower was the victim of identity theft, and the loans are not really theirs.
• If the borrower withdrew and the school failed to properly reimburse their tuition.
• If the borrower was misled by the school — about certification, job prospects, etc.
Negotiating With Your Lender
Private student loan lenders may offer temporary assistance programs that can help borrowers who are struggling to make payments on a short-term basis.
It may also be worth negotiating: You may want to contact the loan servicer or lender and ask for additional repayment options. In general, servicers or lenders would rather receive a smaller sum of money from you than nothing, so it’s typically in their best interest to work with you.
Is Refinancing an Option?
If you’re looking for a long-term solution, refinancing your student loans is worth looking into. Refinancing your student loans means transferring the debt to another lender, with new terms and new (ideally lower) interest rates.
Some borrowers may be able to qualify for a lower interest rate than the federal rate depending on their financial standing. But keep in mind that when federal student loans are refinanced, they lose eligibility for federal student loan borrower protections — like the deferment, forbearance, and income-driven repayment plans mentioned above.
If you’re looking to refinance, make sure you do your research and see if you can find competitive rates with a lender you trust.
💡 Quick Tip: Refinancing could be a great choice for working graduates who have higher-interest graduate PLUS loans, Direct Unsubsidized Loans, and/or private loans.
Starting the Bankruptcy Process
If you are struggling with your student loan payments, they may be the least of your problems next to high-interest credit card debt. Your first step is to consult a debt counselor or financial advisor, who can lay out all your options. If they agree that bankruptcy is your best, or only, path forward, it’s time to find a bankruptcy attorney who has experience with student loans.
The Takeaway
Until the new process that was announced by the Department of Justice in mid-November 2022, the process of seeking federal student loan discharge in bankruptcy was extremely challenging, and success was unlikely. Borrowers generally needed to prove that continuing to repay the loan would place an undue hardship on them and their dependents. But the bar for “undue hardship” was not clearly defined and as a result, hard to prove.
Now Department of Justice lawyers will assist debtors by doing an undue-hardship analysis using three factors — present ability to pay, future ability to pay, and good faith efforts. They will then send their recommendation to the bankruptcy judge, who has the final say. The aim is to help debtors who may not know that they meet the criteria for discharge.
Aside from bankruptcy, federal student loan borrowers who are struggling with their monthly payments (or expect to struggle once the Covid-related payment pause ends) may want to consider deferment, forbearance, or an income-driven repayment plan. The Biden administration has proposed many changes to help borrowers, including forgiveness of up to $20K for qualifying borrowers and a new repayment plan that limits debt payments to 5% of discretionary income.
In some cases, however, refinancing may make sense. Getting a lower interest rate and/or extending the term of your loan can lower your monthly payments, though a longer loan term can mean paying more in interest over the life of the loan. Also, when you refinance federal loans, you lose access to federal protections and benefits.
Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.
FAQ
Can you declare bankruptcy on student loans?
Historically, it was only in rare circumstances that someone could have their federal student loans discharged in bankruptcy. But in mid-November 2022, the Department ofJustice announced a new process where, at the outset of bankruptcy proceedings, it will identify appropriate cases and support discharge. The aim is to help people who meet the requirements for discharge but did not know it.
What happens if you file for bankruptcy on student loans?
Once the new process is in place, you will be able to fill out an attestation form that the Department of Justice will use to determine if it will recommend that your debt or part of your debt be discharged. It’s ultimately up to the bankruptcy judge, but a recommendation from Department of Justice attorneys can go a long way.
Can private loans be discharged through bankruptcy?
Private student loans have on occasion been discharged through a complex process that starts with filing for bankruptcy. Your best bet is to contact a debt counselor or student loan attorney who can assess your situation and determine your odds of success.
How are Chapter 7 and 13 different for student loans?
Chapter 7 bankruptcy is generally for people with few assets and low incomes. Although getting student loan debt discharged through the bankruptcy process has been rare, you had a better chance with Chapter 7. If you file Chapter 13 in order to preserve your assets, you may end up just paying off your student loans on a different schedule. That said, the new process is expected to help more people who can’t pay their debts.
SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.
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