What Is Student Loan Bankruptcy?

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 for struggling borrowers with federal student loans to seek a bankruptcy discharge for their loans 10 years after the first loan payment comes due.

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.

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.

Your student debt is probably just one component of the financial challenges you are currently facing. In fact, 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.

Decide How You Are Filing

Before you can petition a judge to discharge your student loans, you must file 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. You must also undergo credit counseling before court proceedings can begin.

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.

Chapter 7 Bankruptcy

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 personal possessions. The trustee uses the proceeds to pay your creditors as much of your debt as possible, and the court discharges the rest.

To file Chapter 7, you must not have had another Chapter 7 bankruptcy discharged in the past eight years. 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.

Chapter 13 Bankruptcy

People turn to Chapter 13 bankruptcy when they can’t pass the Chapter 7 means test or don’t want to lose their home to foreclosure, which can happen if they have significant equity in the property. Chapter 13, which the U.S. bankruptcy code calls “adjustment of debts of an individual with regular income,” is also known as a reorganization.

Chapter 13 entails creating a repayment plan that uses up to 100% of a debtor’s disposable income to repay creditors within three to five years. Repayment is supervised by the trustee, who collects a monthly payment from the debtor and redistributes it to the creditors as outlined in the repayment plan. 

The bankruptcy court will determine your new monthly debt payments, including your new student loan payment, based on your circumstances. Chapter 13 might help you if you’re struggling to pay student loan debts, and you can’t lower your monthly payment any other way. This might be the case if you have private student loans, which offer fewer options than federal loans when it comes to repayment. 

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.
• 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.
• 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. 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).

The Additional Step: Filing an Adversary Proceeding

Here’s where things get more complicated. As stated earlier, just filing for bankruptcy under either Chapter 7 or Chapter 13 is not enough to have your student loans discharged. You must take the additional step of filing an adversary proceeding.

Under the U.S. bankruptcy code, an adversary proceeding is “a proceeding to determine the dischargeability of a debt.” In other words, it’s a lawsuit within a bankruptcy case. Included in the adversary proceeding paperwork is “a complaint.” The complaint includes administrative details, such as your bankruptcy case number, along with the reasons you are seeking to discharge your student loans in bankruptcy—the circumstances of your undue hardship.

This additional step is necessary because student loans and a few other types of debt have stricter requirements for discharge than credit card debt, for example. These requirements are described in section 523(a)(8) of the U.S. bankruptcy code. The keywording that relates to the discharge of student loans is: “A discharge under…this title does not discharge an individual debtor from any debt…unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents.” Note the words “undue hardship,” which is discussed below.

When to File an Adversary Proceeding: Chapter 7

If you choose to file for Chapter 7, you can file the adversary proceeding right after filing your bankruptcy case. If you’ve already gone through Chapter 7 bankruptcy and your case has been closed, you may still be able to file an adversary proceeding to get your student loans discharged. How much time you have to do so depends on where you live and the courts.

If your Chapter 7 case is already closed, you must first move to reopen your bankruptcy case. This is procedural and does not restart the bankruptcy or eliminate the discharge you may already have received for your debt.

When to File an Adversary Proceeding: Chapter 13

In a Chapter 13 bankruptcy, when you can file an adversary proceeding also depends on the bankruptcy court rules where you live. Regardless of when you file, your student loan nightmare will not be complete if you win the adversary proceeding. That’s because you have to wait until you’ve completed the necessary Chapter 13 plan payments and earned your discharge order for your other debts before your student loans will be discharged.

If you are allowed to file the AP early in your case, you might get the proceeding over with sooner and obtain a decision on your student loans. The table below compares Chapter 7 and Chapter 13 bankruptcy.

“Undue Hardship” and Student Loan Discharge

To succeed in having your student loans discharged, you must demonstrate that not having them discharged would cause you to experience “undue hardship.” For a bankruptcy court to take your side, you will have to meet specific conditions. The problem is that there is no uniform set of conditions.

However, your student loan creditors—which may include lenders, servicers, and collection agencies, depending on the types of loans you have and how far behind you are on payments—must also meet specific conditions. They must satisfy the “preponderance of the evidence” standard, a high standard that requires them to prove that their claims against you are valid. They must also prove that your loans meet the conditions of section 523(a)(8).

The Brunner Test

Most states use the Brunner test to determine what constitutes undue hardship. It’s based on the 1987 case Marie Brunner v. New York State Higher Education Services Corp. This case was heard in the United States Court of Appeals, Second Circuit. Marie Brunner represented herself and lost. Essentially, the test assesses a person’s current financial situation, their foreseeable future situation, and whether they have made a good faith effort to repay their loans.

The reasons for Brunner’s loss are evident in the appeals court findings. She wasn’t disabled or elderly, she had no dependents, and there was no evidence of a “foreclosure of job prospects” in her field—all things that might have prevented her from finding work. In addition, only 10 months had elapsed since her graduation; she had applied for discharge within a month of the due date of her first student loan payment, and she had not requested a deferment, “a less drastic remedy available to those unable to pay because of prolonged unemployment.”

The “Totality of Circumstances” Test

A few states (specifically, those in the Eighth Circuit) use the “totality of the circumstances” test. It might seem that this is an easier standard to meet because it doesn’t consider whether you’ve made a good-faith effort to repay your loans, such as consistent attempts to obtain employment, maximize income, and minimize expenses. However, the totality of the circumstances test also includes an “any other relevant facts and circumstances” component that could be broadly interpreted.

Under either standard, the bar to clear is high, especially for federal student loans, for which the government specifically states that the burden of proof is on the debtor to prove undue hardship.

So, What Really Constitutes Undue Hardship?

Those cases where borrowers have succeeded in having their student loans discharged are insightful. Specifically, a court might agree that repaying your loans would be an undue hardship if you can’t maintain a minimal standard of living for yourself and any dependents, if the hardship will continue throughout the loan’s repayment period, and if you’ve sincerely tried to repay your loans before filing bankruptcy.

What does a court consider a minimal standard of living? Again, case law and some common sense can be a guide. It might mean:

• Your income has been below the federal poverty level for several years and doesn’t show signs of improving.
• You’re on public assistance or dependent on a family member.
• You have a debilitating mental or physical illness or permanent injury.
• You have a child with a serious illness who requires round-the-clock care.
• Divorce reduced your family income with no hope of it returning to its previous level.
• Disability checks are your only source of income.
• You depend on public assistance to support your children.
• You support a spouse who was seriously and permanently injured in a car accident or who has developed a total disability.

The common thread in these examples is that your situation is unlikely to improve in a way that would allow you to repay your debt. In addition, your expenses, which the bankruptcy court will scrutinize, should include only reasonably priced necessities, not luxuries or nonessential purchases such as restaurant meals, brand-name clothing, and vacations—not even giving money to your independent adult child.

Federal Loans and Hardship

Your student loan holder may choose not to oppose your petition to have your loans discharged in bankruptcy court if it believes your circumstances constitute undue hardship. Even if your loan holder doesn’t, it may still choose not to oppose your petition after evaluating the cost of undue hardship litigation.

For federal loans, the Department of Education allows a loan holder to accept an undue hardship claim if the costs to pursue the litigation exceed one-third of the total amount owed on the loan (including principal, interest, and collections costs). Private student lenders are likely to apply similar logic.

Special Considerations

If you plan to claim undue hardship for federal student loan repayment based on physical or mental impairment, you may not need to go to bankruptcy court. You may qualify for automatic discharge under Total and Permanent Disability Discharge.

Other circumstances where you might avoid bankruptcy court and apply for administrative discharge are death, a closed school, a false certification, an unpaid refund, and borrower defense to repayment. Forbearance, deferment, and loan rehabilitation are the other options for managing difficult federal student loan payments.

Please note, however, that as part of the US government’s response to the 2020 economic crisis, all payments and interest on federal student loans are suspended until Jan. 31, 2022. Furthermore, although nothing has been put into action, be aware that President Joe Biden has mentioned his support for forgiving up to $10,000 in undergraduate and graduate student loans. Even better for those with student debt, the American Rescue Plan includes a provision that makes all student loan forgiveness from January 1, 2021, to December 31, 2025, tax-free.

The Bottom Line

Going through the bankruptcy process doesn’t guarantee a specific result, especially since judges will use their unique experience and perspective to inform their decision on your case in addition to past decisions on other cases. Judges will also rely on the outcomes of previous cases that may be similar to yours. That means the court may or may not rule to discharge your student loans.

The outcome of your case will also depend on how your student loan creditors handle it—whether they agree that you’re facing undue hardship and whether it’s worth their money to go to court. These are big companies with attorneys to represent them, which is a good reason to have an attorney representing you.

In the best-case scenario, the bankruptcy court sides with you and agrees that repaying your student loans would cause undue hardship, so all your loans are fully discharged. The worst-case scenario is that you lose your case and still have to repay everything you owe, which may now include collection costs, the additional interest that has accrued, court fees, and attorney fees. Alternatively, you might have your loans partially discharged—or you might get your loans restructured with terms that make them easier to pay back.

Remember, bankruptcy is for people who are in dire need of relief from a serious financial burden. Student loans might only be part of that picture, albeit a significant role, and they require an extra step to be considered for discharge in bankruptcy. Bankruptcy can be an effective way to escape crushing debt if you have a good case. If you don’t, it can be a waste of time, and resources would be better spent pursuing more realistic ways to manage your debt.