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How To File Bankruptcy On Federal Student Loans

What Happens If The Bankruptcy Court Doesnt Discharge My Loans

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Once you move forward with Chapter 7 or Chapter 13 bankruptcy, three possible scenarios might play out. You could see all of your student loans and other debts wiped away completely, your loan could be partially discharged or you could have to repay your loan under better terms, such as with a lower interest rate or monthly payment. You may also fail at having the terms of your loans changed at all during bankruptcy proceedings, which is a risk youll need to take.

If the courts do not find your claim of undue hardship adequate to qualify for bankruptcy, you may have no choice but to carry on in an effort to repay your loans. Some of the options you can consider at this point include:

Featured image by of Shutterstock.

How To Prove Undue Hardship For Student Loans

To discharge student loans via bankruptcy, you will have to prove they pose an undue hardship during your adversary proceeding.

The U.S. Bankruptcy Code doesnt define undue hardship, so bankruptcy courts have different interpretations for its meaning. Most use whats known as the Brunner test to determine whether bankruptcy filers student loans meet the undue hardship standard.

You must prove that you meet all three parts of the Brunner test to get your college debt discharged:

1. Making student loan payments would keep you from maintaining a minimal standard of living based on your current income and expenses. To meet this, you generally must have bare-bones expenses and must have done everything in your power to increase your income, without success.

2. Additional circumstances make it very likely that your financial situation will persist for a significant portion of your remaining loan period. Among other things, you may be able to successfully meet this if you have a serious mental or physical disability, received a poor-quality education or have maximized your income potential in your field.

3. Youve made “good faith” efforts to repay your loans. You may meet this prong by making some loan payments, attempting to negotiate a payment plan and working to slash unnecessary expenses and increase income.

Different jurisdictions and judges have different interpretations of these standards so your outcome will depend on your location and the judge you get.

If You Need Additional Student Loan Help

If youre struggling with your student loan debt, first speak with your servicer or lender to:

  • Discuss repayment options.

  • Take a temporary payment pause.

  • Temporarily reduce your monthly payments.

If your problem is with your lender or servicer or youre not getting the help you need, look for a legitimate student loan help organization that offers counseling. Consider these vetted resources for student loan help they are established organizations with verified histories:

Student loan help resource

Advice on debt settlement, bankruptcy, default and forgiveness. Licensed in Missouri and Illinois.

Many of these organizations offer advice for free. In some cases, you may need to pay a fee, as with a certified nonprofit credit counseling agency or if you hire an attorney.

None of the organizations above calls, texts or emails borrowers with offers of debt resolution.

Offers of help that you have not sought out are likely to be scams. While its not illegal for companies to charge for services such as consolidation or enrollment in a payment plan, those are steps you can do yourself for free.

Avoid any debt relief companies that demand money upfront.

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Are Student Loans Dischargeable In Bankruptcy

In bankruptcy, you can discharge many different types of debt. That includes unsecured debt like credit cards, personal loans, collection accounts, medical bills, business loans and, in some cases, even student loans.

By law, bankruptcy trustees are required to prioritize certain types of debts in regard to when they get paid. For example, things like child support and alimony, unpaid taxes and criminal fines must be paid before your unsecured debts, which are considered non-priority.

While priority debts generally cannot be discharged, you may be able to be released from accounts included in the non-priority category. Student loans are counted among non-priority debts, but youll still have a really hard time discharging them in Chapter 7 or Chapter 13 bankruptcy. The only exception is if you can prove that your student debt has caused undue hardship to yourself and your dependents.

Look Into Loan Forbearance Or Deferment

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Federal student loans offer deferment and forbearance. You can use deferment or forbearance to temporarily pause your payments, usually in three, six, or 12-month increments, until your financial situation gets better. Federal student loan borrowers can get up to 36 months of unemployment deferment and up to 36 months of economic hardship deferment throughout the life of the loan. Deferments are also given to borrowers who are:

  • In school at least half-time

  • In graduate fellowships

  • In a rehabilitation training program for the disabled

  • In treatment for cancer

  • Perkins loan recipients who qualify for deferment under the loan terms

  • Parent PLUS loan borrowers with a student whoâs enrolled at least half-time

Although forbearance and deferment temporarily stop your payments, interest on the loan continues to accrue during the no-payment period. The interest is added to the loan principal when payments restart. If your loans are deferred, the federal government pays the interest during the deferment. If your loans are in forbearance, youâre responsible for paying the accrued interest.

Forbearance is either general or mandatory. Federal student loan lenders may choose to grant general forbearances if youâre facing:

  • Financial hardship

  • Other reasons your loan servicer approves

Federal student loan lenders must grant a forbearance if:

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Options For Dealing With Outstanding Debtstudent Loan Debt Vs Unsecured Consumer Debt

Unsecured Consumer Debt

Consumer proposal Yes Yes, might encounter major problems where the consumer proposal is filed less than seven years from the date of end of debtor?s education
Personal bankruptcy Yes Discharge with respect to student loan indebtedness only available where discharged bankrupt ceased attending school seven years prior to filing for personal bankruptcy, or once a discharged bankrupt has been out of school for five years after the date of filing for bankruptcy a debtor can apply for a court-ordered discharge of their student loan debt

Get A Bankruptcy Attorney

A borrower is more likely to obtain a bankruptcy discharge of their student loans if they are represented by an experienced attorney.

However, most bankruptcy attorneys are unwilling to pursue an undue hardship claim because these cases involve an adversarial proceeding, which are expensive and involve a lot more work. It can cost $10,000 or more to pursue an adversarial proceeding and borrowers who file for bankruptcy usually dont have the money to pay the lawyers fees. Lenders are also likely to appeal the decision, so a favorable decision is unlikely to be final.

Even if you dont have an attorney and are representing yourself pro se, always show up in court. If you dont show up when required, the lender can win the case by default.

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If You Ignore Your Debts

Ignoring your student loan debts is the worst option. Once youre in default on government-held loans which accounted for 90% of all student loans in the 2016-2017 school year the federal government has extraordinary collection powers. It can garnish wages, seize tax refunds or portions of Social Security benefits, and place liens on bank accounts and property.

And unlike other types of debt, there is no statute of limitations on federal student loans. That means that a student loan debtor can be hounded to the grave by the federal bureaucracy or the agency that services loans on behalf of the Department of Education.

Also, after a stipulated number of months of non-payment, a loan can be transferred to a private collection agency. Additional fees and collection costs are then added to the loan balance.

Rather than trying to ignore your student debt problem, its best to take action as soon as possible, even if that means going into bankruptcy.

Alternatives To Bankruptcy For Student Loans

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Since bankruptcy can be an expensive and cumbersome process, most experts see it as a last resort for borrowers. Consider bankruptcy after youve exhausted all other options, like debt consolidation, credit counseling and negotiating with creditors for a lower payment or interest rate.

If youre balancing student loan payments with other expensive, dischargeable debts like credit cards and medical bills, then bankruptcy may be able to provide relief. But if student loans are your only concern, consider these alternatives.

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How Bankruptcy Affects Student Loans

As shown in this graph from the Federal Reserve Economic Database student loan debt has been going up steadily since 2006. As of the second quarter of 2020, outstanding student debt added up to $1.54 trillion.

An interactive version can be found at this link. In part, this is because the cost of higher education has been increasing steadily. But, the perceived inability of student loan borrowers to discharge this type of debt in bankruptcy hasnât helped.

A bankruptcy filing can discharge federal student loans, but only if the bankruptcy judge finds that it would be an undue hardship for the borrower not to do so. Under current bankruptcy laws, this requires the person filing bankruptcy to bring an adversary proceeding.

When To File An Adversary Proceeding: Chapter 13

In a Chapter 13 bankruptcy, when you can file an adversary proceeding also depends on the bankruptcy court rules where you live. Regardless of when you file, your student loan nightmare will not be complete if you win the adversary proceeding. That’s because you have to wait until you’ve completed the necessary Chapter 13 plan payments and earned your discharge order for your other debts before your student loans will be discharged.

If you are allowed to file the AP early in your case, you might get the proceeding over with sooner and obtain a decision on your student loans. The table below compares Chapter 7 and Chapter 13 bankruptcy.

Comparing Bankruptcy Options
Varies by state

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When Do Student Loans Qualify Under Undue Hardship

The criteria for demonstrating undue hardship can vary from court to court, and meeting the standard in any court can be difficult. However, there are two tests courts generally use to determine whether youre experiencing undue hardship from your student loans. Depending on the court, there may be other tests that are used to determine whether you qualify to include student loans in your bankruptcy discharge, but these are the most common:

What To Do About Student Debt

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Before you decide to go down the bankruptcy path, there are a few steps to take that will show youve exhausted all options and that couldhelp your case if you end up before a judge. This can include contacting your loan servicer or lender directly and inquiring about repayment options that could take some of theburden off while still allowing you to remain current.

If they cant sanction a permanent change, then maybe a temporary reduction or payment pause would be approved. Federal student loansmight make income-driven repayment or loan forgiveness possible. But its also possible that you just arent able to make the payments. A past-due status paired withefforts to negotiate repayment is a clear indication that youre experiencing undue hardship and could tip things in your favor should you opt to file forbankruptcy.

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Decide Which Type Of Bankruptcy To File For

Next, on your own or with your lawyer, youll 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 its 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.

The Totality Of Circumstances Test

A few states use the “totality of the circumstances” test. It might seem that this is an easier standard to meet because it doesn’t consider whether youve made a good-faith effort to repay your loans, such as consistent attempts to obtain employment, maximize income, and minimize expenses. However, the totality of the circumstances test also includes an any other relevant facts and circumstances component that could be broadly interpreted.

Under either standard, the bar to clear is high, especially for federal student loans, for which the government specifically states that the burden of proof is on the debtor to prove undue hardship.

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When To Consider Bankruptcy

You should only consider bankruptcy if the situation is extremely dire. Bankruptcy can wreak havoc on your credit, remaining on your report for seven to 10 years. It can also mean losing your assets and in some cases, even your car or home.

Typically, bankruptcy is a better option for private loan borrowers than federal ones. This is because federal loans come with several repayment plans that can drastically reduce your payments .

Its also not an ideal solution if student loans are your only financial issue. This would likely make it hard to prove undue hardship the key to getting those loans discharged. If you consider bankruptcy as a solution for tackling those student loan debts, make sure you have the evidence to prove undue hardship. Well go into that below.

Bankruptcy Discharge Of Student Loans Requires Undue Hardship

The case for allowing students to file for bankruptcy over loan debt

Qualified education loans, which include all federal education loans and many private student loans, cannot be discharged in bankruptcy unless this would impose an undue hardship on the debtor and the debtors dependents . Loans made under a program that is funded in whole or in part by a nonprofit institution are similarly excepted from discharge.

Congress did not define what it meant by the term undue hardship. Since most bankruptcy court cases involve financial hardship, it seems that Congress wanted a harsher standard for student loans, one that presents an unreasonable or excessive burden. But, Congress left it to the bankruptcy courts to define the term.

Originally, Congress allowed student loans to be discharged if they have been in repayment for at least five years. Undue hardship was provided as an alternative for discharging student loans that had been in repayment for a shorter period of time. The option for a bankruptcy discharge after five years was increased to seven years in 1990 and eliminated entirely in 1998, leaving just the undue hardship option.

Most courts have adopted one of two standards for defining undue hardship, either the Brunner Test or the Totality of Circumstances Test .

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How To File For Student Loan Bankruptcy

Discharging student loans comes at the end of the bankruptcy process. Heres what you need to do first.

1. Find a bankruptcy attorney. While an attorney isnt absolutely necessary, working with one especially one with at least some student loan experience can help you navigate the complicated process more smoothly.

Filing for bankruptcy costs anywhere from several hundred to several thousand dollars, depending on your location and the cases complexity. Plus, there are attorney fees for the adversary proceeding required to get student loans discharged.

However, you likely wont qualify for student loan bankruptcy discharge if you can afford an attorney, says Michael Fuller, a Portland, Oregon-based consumer attorney who takes on student loan bankruptcy cases pro bono.

Here’s where to find free legal help:

2. File for Chapter 7 or 13 bankruptcy. You must file for bankruptcy before your student loans can be discharged. Your attorney can help determine the type of consumer bankruptcy thats best for you: Chapter 7 or Chapter 13.

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Consider Hiring A Lawyer

While you dont technically have to go through a lawyer when filing bankruptcy on student loans, bankruptcy can be an incredibly complex process. It requires determining which type of bankruptcy youll file for and submitting an extra lawsuit, called an adversary proceeding . 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 student loan lawyer could actually hurt your chances for discharging your student loans in bankruptcy, according to Fuller. Thats 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 dont know a lawyer, dont worry. You can find one through the American Bar Association. You might be eligible for a lawyer at no cost to you 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.

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