Student loans and bankruptcy: What you need to know

Filing for student loan bankruptcy is never ideal, but sometimes, having debt discharged is the only way forward. This is especially true if you’ve been struggling financially and cannot repay your debts while still maintaining a minimal standard of living.

Many people believe it’s impossible to get student loans discharged in bankruptcy. That’s not the case — though you have to prove paying down the loans is causing you “undue hardship,” historically a complicated process.

The U.S. Department of Justice and Department of Education recently announced that the new guidelines for discharging student loans in bankruptcy have led to an increase in borrowers applying for and qualifying for debt relief.

How to file for student loan bankruptcy

Declaring bankruptcy on student loans is not easy. And it will affect more than just your college debt. Here are the steps to follow:

1. Find a lawyer. The first step to filing for bankruptcy with student loans is locating a lawyer who has expertise in this area. It’s important to find an experienced professional, as not every lawyer works with student loan discharge. If you don’t know where to start, services like Upsolve — a nonprofit organization that provides free bankruptcy filing tools —  could help you in the process. However, you should know that bankruptcy can cost thousands of dollars. Being able to afford the attorney fees may mean that you’re ineligible for discharge based on undue hardship: Lawyers can argue that if you can pay attorney fees, you can repay your debts.
2. Seek a free consultation. Some student loan lawyers might offer a free consultation. If so, take advantage of it. An attorney can go over your options and let you know if bankruptcy is a viable option for your situation.
3. Decide if you will file for Chapter 7 or Chapter 13 bankruptcy. You’ll need to choose between Chapter 7 or Chapter 13 bankruptcy, which have different rules regarding which assets you keep and what you’re required to pay. Your attorney can help you consider your bankruptcy options and determine which is the best fit for your financial situation.
4. File a separate adversary proceeding to discharge your student loans. This filing is similar to a lawsuit, but it happens in bankruptcy court. During the proceeding, you’ll have to meet the undue hardship standard. According to the U.S. Department of Education, you must be able to “demonstrate that repayment would impose undue hardship on you and your dependents.” Your creditors or representatives of your creditors may also show up at the proceeding to challenge your claims.
5. Wait on a decision. There are several potential outcomes to an adversary proceeding. The court may decide to grant your petition to discharge all of your student loans. It might also opt to grant a partial discharge of part of your loans, or no discharge at all.

Chapter 7 vs. Chapter 13 bankruptcy

Which type of bankruptcy should you consider? The answer to that question depends on your ability to work and receive a regular income, as well as the outcome you hope to achieve.

The two most common types of bankruptcy for consumers are Chapter 7 and Chapter 13. Here is how they differ.

How to prove undue hardship for student loans

While undue hardship can look different for each person, this term describes a situation where it would be practically impossible to repay your student loans. Historically, it has been a high threshold for student loan borrowers to meet.

There are three prongs to proving undue hardship:

1. Undue hardship would describe any situation where someone cannot pay their student loans and pay for a roof over their head or put food on the table. If you racked up significant student loan debt but became incapacitated and unable to work after a car wreck, for example, you could potentially qualify. If you cannot maintain a minimal standard of living, you could prove that repayment of the student loan is an undue hardship.
2. Undue hardship also needs to be likely to continue for a significant portion of the loan repayment period, notes the U.S. Department of Education. In other words, a medical student who is drowning in debt cannot file bankruptcy on their loans, have them discharged and then go on to earn a significant income a few years later.
3. You also have to make a good-faith effort to repay your loan before moving forward with bankruptcy. If you don’t, it’s less likely that you’ll be successful in bankruptcy court.

What happens if the bankruptcy court doesn’t discharge my loans?

Once you move forward with Chapter 7 or Chapter 13 bankruptcy, four possible scenarios might play out.

• All of your student loans and other debts are discharged.
• Your loans are partially discharged.
• You must repay your loan under better terms, such as with a lower interest rate or monthly payment.
• Your loans and their terms do not change at all.

If the courts do not find your claim of undue hardship adequate to qualify for bankruptcy, you may have no choice but to continue trying to repay your loans.

How Justice Department changes have made student loan bankruptcy easier

On Nov. 17, 2022, the Departments of Justice and Education announced changes in how student loan discharge will be treated in future bankruptcy cases.

Under the new guidelines, borrowers seeking student loan discharge must submit a form detailing their income, household situation and economic hardships. The Department of Justice will then evaluate this form in consultation with the Department of Education. The Justice Department will advise the judge on whether to grant full or partial discharge of the loans in question. However, the final decision is up to the bankruptcy judge.

The main goal of this form and review process is to ensure consistency and equity when courts handle student loan bankruptcy. That way, distressed borrowers have a fair chance of getting their debt discharged.

A year after these new guidelines were put in place, the Department of Justice and Department of Education announced more borrowers are applying for and receiving debt relief from student loan bankruptcy. Their press release stated that nearly all borrowers voluntarily use the streamlined method, and the “vast majority” have received full or partial discharges.

Possible alternatives to student loan bankruptcy

Filing for bankruptcy can definitely bring some much-needed relief if you’re struggling financially. However, the consequences of filing for bankruptcy are long-lasting, which is why it should be your last resort.

If you can balance your other financial obligations aside from student loans, explore the following options before deciding.

• Apply for an income-driven repayment plan. If you only have federal student loans, income-driven repayment plans let you pay a percentage of your discretionary income for 20 to 25 years before forgiving your remaining loan balances. Because your payments will fluctuate with your income, your payments could be much lower than they are now.
• Look for federal loan forgiveness programs. Public Service Loan Forgiveness is available for individuals willing to work in qualifying public service positions and make payments on an income-driven repayment plan for 10 years. There are also other types of loan forgiveness plans you can explore.
• Ask for temporary deferment or forbearance. If you need temporary relief from private or federal student loans, look into deferment and forbearance, which let you pause payments on your loans for a limited time. Remember that interest may continue accruing during forbearance, which could worsen your problem.
• Refinance your student loans. This option won’t work for everyone, but you could refinance your student loans with a private lender that might offer a lower interest rate or a monthly payment that you can afford. But if you refinance federal student loans, you’ll lose access to administrative forbearance options, forgiveness programs and income-driven repayment plans, as you’d be turning your federal loans into private ones.
• Contact consumer advocacy organizations. If you’re worried about defaulting on your student loans, national organizations can help you apply for repayment options, investigate debt payoff plans or explore loan rehabilitation.

The bottom line

Getting student loans discharged through bankruptcy can be complicated. However, new rules and guidance could make the process easier for distressed borrowers.

That said, filing for bankruptcy can cost thousands of dollars and cause long-term consequences. It shouldn’t be taken lightly. It’s important to exhaust all other options to make your payments more manageable before going down this route.