Filing for bankruptcy for student loans can be a wise decision, especially if you’re struggling to pay your bills.
There are two types of bankruptcy that can help you get out from under your student loans: Chapter 7 and Chapter 13.
Chapter 7 is known as “straight bankruptcy,” because it wipes out all of your unsecured debt—like credit cards and medical bills—and leaves you with an opportunity to rebuild from scratch.
Chapter 13 is called “reorganization,” because it allows you to keep making payments on your debt while also paying some of what you owe over the life of the plan.
Filing For Bankruptcy For Student Loans
You may have heard that student loans cannot be discharged in bankruptcy. That statement oversimplifies the truth. You actually can get student loans discharged in some cases, but the bar is higher, and the process is more burdensome than it is for other types of debt.
Filing for bankruptcy to discharge student loans may get easier, though, if a recently introduced bipartisan bill is passed. The Fresh Start Through Bankruptcy Act of 2021, by Senators Dick Durbin (D.-Ill.) and John Cornyn (R-Texas), would restore the ability of borrowers with federal student loans to seek a bankruptcy discharge for their loans 10 years after the first loan payment comes due.12
It would also make it possible to retain the existing undue hardship discharge option for private student loans and for federal student loans that have been due for fewer than 10 years.1
KEY TAKEAWAYS
Under U.S. bankruptcy law, student loans are significantly harder to get discharged than other types of unsecured debt, but it is sometimes possible.
Getting student loans discharged in bankruptcy requires an extra step to file an “adversary proceeding.”3
Before declaring bankruptcy, make sure you have considered all the alternatives, such as deferment, forbearance, and income-driven repayment.
A bankruptcy specific to student loans does not exist
The IRS may keep any tax refund and apply it to your federal loans if they are in default.
How Student Loan Bankruptcy Works
If you’re considering student loan bankruptcy, falling behind on your payments will have had a major impact on your life. Perhaps your wages have been garnished because a lender took out a judgment against you. The federal government may have kept your tax refund and applied it to your federal student loans because they were delinquent or in default.4
Your student debt is probably just one component of the financial challenges you are currently facing. If student debt is your only problem, you are unlikely to succeed in getting it discharged through bankruptcy. Filing for student loan bankruptcy is not easy and does not guarantee that you will walk away debt-free. But if your credit is shot, bankruptcy could be a faster path to financial health than continuing to struggle to pay your debts.
There is no special type of bankruptcy called “student loan bankruptcy.” Succeeding in having student loans discharged through bankruptcy involves filing Chapter 7 or Chapter 13 and then taking an additional step, which is filing an “adversary proceeding,” or AP. The AP must be filed to have your student loans considered for discharge.3
Decide How You Are Filing
Before you can petition a judge to discharge your student loans, you must file for Chapter 7 or Chapter 13 bankruptcy. This requires completing extensive paperwork and disclosure of your assets, income, debts, and expenses. The bankruptcy court will assign an impartial trustee to meet with your creditors to confirm your debts.5 You must also undergo credit counseling before court proceedings can begin.6
Declaring bankruptcy can help people catch up when they’ve fallen behind on their finances by halting collection activities and stopping the downward debt spiral. Once you file bankruptcy, debt collectors must leave you alone until the court permits them to resume collections or until your case is complete. In addition, wage garnishment must stop.7
chapter 7 bankruptcy student loans
In a Chapter 7 bankruptcy or liquidation, the trustee will sell off your nonexempt assets. Exempt assets vary by state but often include your primary home, a sensible vehicle, and your possessions. The trustee uses the proceeds to pay your creditors as much of your debt as possible, and the court discharges the rest.7
To file Chapter 7, you must not have had another Chapter 7 bankruptcy discharged in the past eight years.9 Also, your current monthly income must fall below the state median or must pass a means test. Certain debts cannot be discharged, such as taxes, alimony, and child support. The whole process can be over in a few months, depending on the complexity of your case. Once your case is complete, you can file for student loan discharge.7
Filing for Student Loan Bankruptcy
In addition to considering which type of bankruptcy is more suitable, there are additional factors to consider before pursuing a bankruptcy filing.
- You could end up owing more on your loans. There can be major drawbacks to using Chapter 13 bankruptcy to get student loans under control. The bankruptcy court will decide how much you will pay each of your creditors each month. If you have other debts that are legally categorized as a higher priority than student loans, you could end up accruing additional interest on your student loans if the court lowers the size of your payments.8
- You shouldn’t file if your only debt is your student loan. The Department of Education takes a dim view of this, noting, for example, that it could indicate an intentional strategy to avoid repaying your student loans. If you have no other debt, you are not likely to win your case. Student loan discharge is reserved for people whose circumstances are beyond their control.3
- Success could depend on which type of loan you have. You may have a better chance of discharging or settling a private student loan in bankruptcy than a federal student loan. The reason is that federal student loans offer income-driven repayment (IDR) plans while private student loans do not.11 Many courts may conclude that if you qualify to participate in an IDR plan, you should be able to repay the debt.
- Filing costs money. You must pay court filing fees unless the court waives them, and it’s wise to have a bankruptcy lawyer with a track record of getting student loan debt discharged. However, if you can afford an attorney, the court might find that your circumstances aren’t dire enough to warrant a student loan discharge. Look for a lawyer that might take on your case pro bono (“for the good”) or for a fee the court would find acceptable (visit the American Bar Association or your state bar association’s website to find a lawyer).
Bankruptcy remains on your credit history for up to 10 years. If your credit score was good before you filed, it can take a serious hit after you file.12