Everything You Need to Know About Filing for Bankruptcy on Student Loans
Student loans and bankruptcy is a complicated topic, and not many bankruptcy filers understand how bankruptcy affects their student loan debt. Read on to find out what your options are and how they differ depending on whether you file for Chapter 7 or Chapter 13 bankruptcy.
If credit card debt, medical bills, and other loans are getting in the way of paying your student loans, schedule a free consultation to tell The Wink Law Firm your story and find out how we can get you the results you’re looking for.
Student Loans and Bankruptcy During the Biden Era (Updated October 2023)
The Department of Justice (DOJ), which enforces student loan payment for the Department of Education, has recently lessened their aggressive approach to blocking student loan holders from discharging these loans in bankruptcy.
As we explain below, student loan debt is typically not dischargeable in bankruptcy without the Debtor who filed bankruptcy initiating an adversary proceeding where you must prove that your student loan debt has created “undue hardship.” For federal student loans, the Department of Justice handles these adversary proceedings. Historically, the Department of Justice (and private attorneys for private student loan lenders) have taken a very aggressive approach to combating claims of “undue hardship.”
In an attempt to lessen the burden on people who face “undue hardship” from repayment of their student loans, the DOJ under President Biden has recently streamlined these adversary proceedings to a questionnaire. For certain people who are lower income with minimal assets, the DOJ will likely not fight student loan discharge as rigorously as before. This means that, in some cases, you may be able to discharge your student loans in bankruptcy more predictably and cost-effectively than before.
Keep in mind that the information that follows has largely applied to student loan debt since 1998. If you want to explore your options for student loan debt, including credit card debt settlement, schedule a free consultation with The Wink Law Firm.
Most Student Loans Are Not Dischargeable in Bankruptcy
Under bankruptcy law, the starting point is that student loans are not dischargeable in bankruptcy. That means you will still owe them when your bankruptcy is over. (They used to be dischargeable after seven years of repayment, but Congress changed all that in 1998).
Now, the only way to get rid of your student loans in bankruptcy is to claim that repayment of the loans creates an “undue hardship”. The only way this can be proven is through what is called an adversary proceeding. This is like a separate lawsuit within your bankruptcy case. It often involves litigation, including expert witnesses and depositions. As a result, it is not cheap.
Aside from costing you a good chunk of money, winning an “undue hardship” discharge is incredibly difficult. Most courts, including Colorado, follow the test set out in the Brunner case out of New York (831 F.2d 395). Brunner is a three-part test in which you must prove:
- That the debtor cannot both repay the student loan and maintain a minimal standard of living.
- That this situation is likely to persist for a significant portion of the repayment period of the student loans.
- That the debtor has made good faith efforts to repay the loans.
This test is applied very strictly, with the minimal standard of living judged as living at the poverty level with no discretionary expenses at all. Additionally, discharges are not usually granted absent permanent disability of the debtor (or possibly one of the debtor’s dependents). More information is available on this topic at FinAid.
This interpretation of “undue hardship” coupled with aggressive defense put on by student loan lenders has meant that discharging student loan debt in bankruptcy is unpredictable, except that we know it will cost a lot to find out. Bankruptcy is generally a very efficient and cost-effective means to get out of many types of debt (e.g., credit card debt, medical bills, and many types of small business debts). However, the adversary proceeding required to attempt to obtain a discharge of student loans is much more costly and inefficient. Attempting to get out student loans in bankruptcy has often meant increasing the total cost of the bankruptcy by 5 times, 10 times, or even more. This is especially problematic because those who have a chance of establishing the “undue hardship” required to get a student loan discharge don’t have much money.
The change from the Department of Justice may help lower-income people with nominal assets achieve a discharge of their student loans more cost-effectively. While this is generally a good thing, it is still problematic because the requirement of initiating an adversary proceeding and completing the DOJ’s questionnaire likely at least doubles the cost of the bankruptcy. Again, this is significant because the only folks who will benefit from this DOJ’s change are without the means to afford much. Additionally, for all but the poorest bankruptcy filers, discharge of student loans is simply not an option. However, if you’re also struggling with other forms of debt, like credit card bills and tax debt, schedule a free debt settlement consultation with The Wink Law Firm to find the financial freedom you need.
Student Loans in Chapter 7 Bankruptcy
When you file for bankruptcy, you are instantly protected by the automatic stay, which prevents creditors from attempting to collect on the debts you owe them. This protection applies to student loan lenders, and as a result, your loans will be put into automatic forbearance once your case is filed.
Interest continues to accrue during the time your bankruptcy case is open, and you will be responsible for those amounts. However, you can take a break from paying your regular loan payments while your Chapter 7 bankruptcy is pending.
This is the easiest way to handle student loans in bankruptcy. Often, your loans are sold once you enter bankruptcy or are transferred to a different department, and if you try to make your regular payment, they may not be properly credited.
If you plan to continue to make payments, it is important to communicate with your lender once you file your case and to keep records of any payments you make while your bankruptcy case is open.
Student Loans in Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, which requires steady income and involves a monthly payment for the three-to-five-year life of the plan, student loans can be dealt with in two different ways. First, your student loans can be placed “in the plan” and a portion of your monthly payment might go toward the loan balance(s). However, this monthly amount is likely to be smaller than your regular payments, and this approach will not stop interest from accruing on the loans, which means the balance owed on your student loans will be greater after your Chapter 13 plan ends.
The automatic stay applies for the life of your Chapter 13 plan, and the student loan lenders must accept the smaller payment amount while you are in Chapter 13 bankruptcy (3-5 years). While these payments will be credited to what you owe (interest and possibly even principal), the lender can hold you to the terms of your loan agreement in collecting remaining principal and interest after you exit bankruptcy.
There is a second way to handle student loans in Chapter 13 bankruptcy, and that is to pay the loans “outside of the plan.” The benefit of this approach is that you can continue to make regular payments on the loans and keep interest from piling up during the years you are in a Chapter 13 repayment plan. However, this is often limited as a practical matter because many do not have enough money to make their student loan payments while also making a Chapter 13 bankruptcy payment.
For those who can afford to continue making payments outside the plan, the bankruptcy Trustee may well challenge this approach if your other creditors are getting only a fraction of what you owe through the bankruptcy. Your ability to prevail in such a situation depends on a number of factors, and such cases are best handled by an experienced bankruptcy attorney.
For those with significant student loan debt who will have a relatively high Chapter 13 plan payment because of their income or assets, having the student loans participate in the bankruptcy can actually be a way to accelerate repayment of the student loans while decreasing the amount available for your other creditors. This is because unsecured creditors, including student loan lenders, typically participate in the distribution from the Chapter 13 plan on a pro rata basis. For example, if you have $100,000 of student loans and $50,000 of other unsecured debt (credit cards, medical bills, etc.), the student loans will get two-thirds of the distribution to unsecured debt through their Chapter 13 plan. This benefits the Debtor in bankruptcy because much of their Chapter 13 plan payment for three to five years is going to debt they won’t get out of in bankruptcy at the expense of debt they will get out of in bankruptcy.
Do you need further help with your finances? We also specialize in settling credit card debt, past-due medical bills, and tax debt with our effective bankruptcy and debt settlement solutions.
What to Do After Your Bankruptcy Discharge
Your student loans probably changed hands while your bankruptcy was pending. (Most student loans are sold to a company called ECMC once you file bankruptcy). After your bankruptcy is over, or while your bankruptcy is pending, if you plan to continue repayment, it is important to find out who holds your loans. The National Student Loan Data System can help you find out. Once you find out who your lender is, you should contact them to discuss your repayment options.
If your student loans were in default before you filed for bankruptcy, they will continue to be in default until you work something out with your lender, such as loan rehabilitation or a default repayment plan. (Student loans go into default if you fail to make a payment for 270 days).
Bankruptcy will not put your student loans into default. If your credit report after bankruptcy incorrectly reports the status of your loans (such as showing loans in default when you are sure they are not, or reporting that your loans were discharged in bankruptcy – they were not, unless you won an adversary proceeding against your lender) you must dispute the incorrect status with the credit bureau.
Having student loans can be a good way to begin rebuilding your credit score after your case is closed. Provided you make on-time payments and continue to pay down the balance, your student loan debt will provide a means of establishing a good credit history without taking on new debt after your bankruptcy is over.
Student loans are very difficult to get rid of in bankruptcy. You need to have real hardship and money to invest in a lawsuit (odd combination, I know). Assuming this is not you, you should have a plan for how to manage your student loans during and after bankruptcy.
This is especially true in Chapter 13, where student loans present particularly thorny practical and legal issues while in bankruptcy. If you’ve read our blog in the past, you can probably guess the exciting conclusion – this is a good reason to hire a bankruptcy lawyer.
Find Relief with Denver’s Leading Debt Settlement and Bankruptcy Lawyers
The Wink Law Firm provides affordable legal strategies that are customized to your particular needs. We provide a new path forward for Denver-area residents who are looking for freedom from debt. Even if your student loans cannot be discharged, The Wink Law Firm can help with other debts you have accrued so that you can successfully make student loan payments.
Schedule a free consultation with The Wink Law Firm’s Denver bankruptcy attorneys or call us at (720) 523-0620 to learn more about these possibilities:
- Debt settlement negotiations to potentially pay half of what you owe
- Small business debt relief
- Chapter 7 bankruptcies that position you to rebuild credit score and get mortgage eligibility within two years.
- Effective payment plans for Chapter 13 bankruptcy
- Debt relief for divorcing or just-divorced couples
- Tax debt resolution
- And much more