Bankruptcy can be a way to get your finances back on track, but it isn’t for the faint of heart: It’ll be on your credit history for seven to 10 years, which will make it more difficult for you to qualify for a mortgage or auto loan or get a lease on an apartment. When it comes to student loans, you might have heard that they can never be discharged in bankruptcy — but that’s a common misconception.
This belief might explain why only 0.1% of debtors attempted to have their student loans forgiven, or “discharged,” through bankruptcy in 2007, according to a study on bankruptcy filings. But of those who tried, 39% got at least partial discharge. So although it’s hardly a shoo-in, there is some possibility.
First, talk to your loan servicer about your circumstances and take advantage of other repayment options, including deferment and forbearance. That’ll both help ease your burden and increase your chances of finding student loan relief through bankruptcy.
If you decide to go ahead, you’ll most likely file for one of the two main types of personal bankruptcy protection: Chapter 7 (liquidation) or Chapter 13 (reorganization). Both carry the opportunity to reduce or eliminate your student debt. And, in either case, all wage garnishments and collection attempts, such as phone calls and letters, will stop while your case is open.
How it works
Like a few other types of debt, student loans are initially exempt from discharge when you file for bankruptcy. That doesn’t mean they can’t be discharged at all — but it will require an extra step in your Chapter 7 filing known as adversary proceedings. That’s when you take your loan holder to court within your bankruptcy filing.
Once you’ve started that process, there are a couple of tests the courts use to determine whether your payments would pose an “undue hardship.” The more common test is called the Brunner Test, named after the 1987 Brunner v. New York State Higher Education Services Corp. case. It has three parts:
- You must prove that your payments would keep you from maintaining a “minimal” standard of living.
- You must prove that additional circumstances, like disability or other health issues, will keep you from making your payments for a significant portion of the remaining repayment period on your loan.
- You must prove that you’ve made good-faith efforts to repay your loans, like changing your payment plan or contacting your student loan servicer.
Congress has never defined “undue hardship” in the bankruptcy code, so there’s a lot of room for interpretation. That means your outcome will depend heavily on external factors, such as who oversees your case and what state you’re in. Generally, though, good bets for discharge usually include loans for fraudulent schools and individuals with permanently debilitating medical issues that would make it impossible to earn a living.
Chapter 7 cases take four to six months to complete and stay on your credit history for 10 years, but those with a steady income may not qualify for it. If you don’t qualify or you’re not able to prove undue hardship, you may be able to opt for Chapter 13, which sets you up on a payment plan for all your major debts.
“It’s useful for folks who have fallen behind the more serious debts, like taxes, house or car payments. Chapter 13 lets them repay those debts over a period of time,” says Ed Boltz, president of the National Association of Consumer Bankruptcy Attorneys.
The biggest upside to Chapter 13 is that the court, not your student loan holder or servicer, dictates how much you’ll pay each month. However, if you aren’t able to stick to those payments for the three to five years Chapter 13 cases usually take, your case will be dismissed and your accounts will go back into collections. After you come out of Chapter 13 bankruptcy, which stays on your credit history for seven years, you’ll have to start making regular payments on any remaining debts.
Financing your bankruptcy
Filing for bankruptcy can be expensive in itself, costing anywhere from hundreds to thousands of dollars. And adding adversary proceedings to your list will increase the cost. With Chapter 7 bankruptcy, you’ll have to pay your attorney upfront. That’s because the debts that would be erased would have to include your lawyer’s fees. In Chapter 13 bankruptcy, you can work out a payment plan with your lawyer. However, since Chapter 13 takes so much longer and requires more billable time from your lawyer, it’ll likely end up costing much more than filing for Chapter 7.
“First, I’d meet with the attorney and talk about the best ways to pay for it,” says financial expert and NerdWallet columnist Liz Weston. “Maybe you don’t want to take another job because it could change your income level. A better approach may be to stop paying certain bills and start hoarding up that money for a few months.”
If bankruptcy appears to be your only option, it is possible to get relief that way. But Weston says you can probably expect to get more relief from other debts, such as medical expenses and credit cards, than from student loans.
“I think that the mindset you want to have is that this is a very, very difficult thing to get. But that doesn’t mean that you can’t get relief in bankruptcy court from other debts,” she says.
More from NerdWallet
3 ways to tackle private student loans
4 signs you’re ready to refinance federal student loans
Private student loan forgiveness is a myth, but try these tips
Devon Delfino is a staff writer at NerdWallet, a personal finance website. Email: ddelfino@nerdwallet.com. Twitter: @devondelfino.
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