When you are financially underwater, one way of eliminating your debt is to declare personal bankruptcy. If you have unpaid student loans, you might think these might be discharged during the bankruptcy process. But, this isn’t always the case as student loans are viewed differently than other forms of debt. Here are some circumstances when you can and cannot declare bankruptcy on a student loan.
Two Different Types of Personal Bankruptcy
Before we look into how you might be able to discharge your student loans, it is important to know that there are two different chapters (types) of personal bankruptcy.
Chapter 7 is declared when are experiencing extreme poverty and cannot pay your bills due to having little disposable income and cannot repay any of your bills.
Chapter 13 is when you have a larger disposable income and can at least repay a portion of your bills. Under Chapter 13 bankruptcy, you might be required to restructure your payments and will still be responsible for repaying all or some of your debt.
With either chapter of bankruptcy, you will need to prove “undue hardship” regarding your student loan payments. You also might need to hire a bankruptcy lawyer to help navigate you through the process to improve your odds of qualifying for discharge.
When You Can Declare Bankruptcy on a Student Loan
Let’s start with when you can declare bankruptcy on your student loans. Although to be upfront, you will need to demonstrate some extenuating financial circumstances (i.e. undue hardship) to allow the loans to be discharged and no longer be held responsible for the monthly payment.
Demonstrating undue hardship is the only way to discharge your student loans in the bankruptcy process. Simply not having a low disposable income or high debt-to-income ratio will help you like it would with types of debt.
The three actions listed below are a great way to prove undue hardship:
- Have minimal disposable income to pay bills.
- Your financial situation will not improve soon.
- You have made a “good faith” effort to pay your bills each month.
This is called the Brunner Test and is used in most, if not all, bankruptcy proceedings.
Also, declaring bankruptcy on your student loans will probably occur during a separate hearing. It’s very common for bankruptcy judges to exclude student loans from the normal bankruptcy process.
Attended a For-Profit School
Undue hardship will be the most likely possibility to discharge your student loans, but, if you attended a for-profit school, your odds might be a little better as well. This is because the default rates at certain schools are the highest in the nation. Other possible defenses include lender’s breach of contract, fraud, or deceptive business practices.But, using this argument is going to be more of a lawsuit to sue the school or the lender instead of showing your own personal hardship.
Actions To Take Before Declaring Bankruptcy
Declaring bankruptcy on your student loans should be an action of last resort. This is because bankruptcy will remain on your credit history for at least 7 years and will severely damage your credit score, making it harder to qualify for financing and receiving quality job offers in the future. Plus, if you cannot prove “undue hardship,” you are still responsible for paying your student loans.
Since it is very hard to discharge your student loans, there are some actions you should take first. In fact, the bankruptcy court and any lawyers you might hire will see if you have followed some of these steps first as they can help ease the burden of your current student loan payments.
Federal Student Loans
If you have federal student loans, you have many options that private lenders do not offer. The easiest way to potentially reduce your monthly loan payment is to enroll in an income-based repayment plan.
These plans cap your monthly federal loan payment to anywhere from 10% to 20% of your adjusted growth income depending on which repayment plan you enroll in. And, depending on your employer, the loans can also be forgiven after 10 or 20 years of payments.
The second option with federal loans is to consolidate them through the Department of Education. Your new interest rate will be the weighted average of your existing interest rates and you can extend the repayment term from the standard 10-year term to 20 years.
Private Student Loans
With private student loans, your best option of showing a “good faith” effort to make your student loan payments is to refinance your student loans. Private refinancing allows you to potentially qualify for a lower interest rate in addition to extending your repayment term. And, if your finances improve, you can repay your refinanced loan early and not be penalized!
It is possible to declare bankruptcy on your student loans, but, most judges might require you to repay the balance unless you qualify for undue hardship. To improve your chances of qualifying or to not declare bankruptcy at all, applying for refinancing or income-based repayment plans are the first step you should take when you struggle to make your current student loan payment.