Can You File Bankruptcy on Student Loans? – Councilor Forbes
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It is possible to get free from student loans through bankruptcy. The standard most commonly used by the courts to determine your student loan release eligibility is strict; and if you meet it is subject to the judgment of the individual bankruptcy court. But that doesn’t mean you shouldn’t try.
To be successful in obtaining the discharge of private and federal student loans in bankruptcy, you must demonstrate that repaying the loans is “undue hardship” for you and your dependents. That’s a higher standard than those who file for bankruptcy must meet to pay off their credit card debt, personal loans, or overdue utility bills. In many cases, however, it’s worth trying to show that you meet this standard if you have a case for it.
There are alternatives to bankruptcy if your loan payments are unaffordable, and since bankruptcy has serious consequences for your credit and financial life, consider them first. If bankruptcy is the right choice for you, here’s how it can eliminate or reduce student debt.
What you need to know about bankruptcy
There are two types of bankruptcy: Chapter 7 (the most common) and Chapter 13. In both cases, if you are successful in filing your case, you will not have to pay off certain debts, and wage garnishment. and other debt collection activities will end. .
Chapter 13 bankruptcy gives filers who have constant income a payment plan to pay off their debts within three to five years. The remaining debt is paid after this period. In Chapter 7 bankruptcy, there is no payment plan and discharge may come sooner, but your qualifying assets will be sold to pay off your debts. After that, any remaining debt will be discharged.
Either way, there’s a downside: Bankruptcy will show up on your credit report for 10 years if you file for Chapter 7 and seven years if you file for Chapter 13. And unless you choose Chapter 13. , you could also lose the collateral you placed. down to secured debt, like a mortgage, that has not been paid and has a lien — or a legal claim — against it.
Related: 7 Easy Ways To Rebuild Your Credit After Bankruptcy
How to get student loan discharge in bankruptcy
Student loans must pass an additional test to be eliminated in bankruptcy. Many courts use the Brunner Test, named after a 1987 court case, to determine if your loans are “undue hardship” on you and your dependents. You can prove undue hardship by showing that:
- Student loan repayment prevents you from maintaining a “minimum” standard of living for you and your dependents, based on your current income and expenses
- This is unlikely to change for the rest of the loan repayment term
- So far you have done your best, or made a “good faith” effort to repay the loans.
To file for bankruptcy, you will first need to complete a mandatory credit counseling course, and then submit your debt and financial details to the United States Bankruptcy Court. For a Chapter 7 procedure, you will need to show that you are unable to pay the debts within your means. A bankruptcy trustee will be appointed to manage the liquidation of assets under Chapter 7 and the repayment plan under Chapter 13.
You will need to take an additional step in the bankruptcy process to request the cancellation of your student loans. This is called adversarial proceedings, and it will ask the court to determine that you meet the undue hardship test based on the financial circumstances you provide in your petition.
You will have to pay filing fees and all attorney fees when filing for bankruptcy. Hiring a lawyer is a wise move due to the complexity of paying off student debt in bankruptcy. A knowledgeable lawyer can help you draft a solid adversarial proceeding and advise you on the course of action that will lead to the best outcome for you.
If you are unable to meet the undue hardship standard, you may consider filing for Chapter 13 bankruptcy and receiving a new monthly student loan payment based on your court-mandated payment plan. This can give you a lower payment or the ability to pay off your loans faster while other debt payments are reduced. After three to five years, you can then attempt to pay off the remainder of the balance due to undue hardship.
Alternatives to bankruptcy for student loans
Since bankruptcy can be an expensive and cumbersome process, most experts see it as a last resort for borrowers. Consider bankruptcy after exhausting all other options, such as debt consolidation, credit counseling, and negotiating with creditors for a lower payment or interest rate.
If you balance student loan payments against other expensive and dischargeable debt like credit cards and medical bills, bankruptcy may be able to provide relief. But if student loans are your only concern, consider these alternatives.
Income-based repayment plans
Federal student loans come with a host of important protections for consumers, and the most useful for borrowers may be the Income-Based Repayment Program (IDR). This limits monthly payments to a percentage of your income and offers a discount on the remaining balance after 20 or 25 years. You can apply online for free at studentaid.gov. Most private lenders do not offer this option.
Federal loan rehabilitation
If your federal student loans are already in default – that is, they are at least 270 days past due for most student loans – you can take a structured default route. Rehabilitation requires you to make nine one-time monthly payments at 15% of your income. Upon successful completion, the default rating will be removed from your credit report. You can then also request an IDR plan to make your remaining payments more manageable.
Federal loan consolidation
Another post-default option for federal student loans is consolidation: you will combine your federal loans into one loan and make three monthly payments on time, or agree to repay the consolidation loan on an IDR plan. At this point, your loans will no longer be in default. But unlike after rehabilitation, the rating will remain on your credit report.
Private loan modification or settlement
Your options for reducing private loan payments or getting out of default vary widely depending on the lender. Contact your lender or private manager directly to explore loan modification programs if you can’t afford your long-term payments.
If you are behind on your loans, you might consider entering into a settlement agreement with the lender or collection agency. At this point, you would pay a lump sum amount that is less than your total outstanding balance. But you might have to pay tax on that amount, and it might be unaffordable.
If you can, consult a tax professional or student loan lawyer if you are in contact with a collection agency about a settlement.
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