Does Bankruptcy Clear Student Loan Debt?

Anyone struggling with student debt probably asks whether or not does bankruptcy clear student loan debt.

As something that might seem to be a solution, declaring bankruptcy is a challenging task in itself.

Unfortunately, it is not as easy as many individuals think, and it can have serious long-term ramifications.

What Is Student Loan Bankruptcy?

When researching ways to relieve yourself of student debt, you might read that claiming bankruptcy is an option.

Although some people make it sound simple, it’s not as easy as 1-2-3.

In truth, declaring bankruptcy is one of the most challenging and costly options for discharging student loan debt.

With that said, it doesn’t mean that it is impossible, but you can be sure it will take a long time to reach a resolution.

Also, there are a significant number of financial hurdles that you’ll need to leap over.

It’s important to remember that with this type of declaration, all of your personal information will be combed through as well.

In plain terms, declaring bankruptcy with your student loans means you don’t have the means to pay off your loan.

However, it requires much more than simply letting your loans default by not paying.

You also need to prove that you have considered all other alternatives, especially with federal student loans.

Student Loan Bankruptcy and Undue Hardship

A term you’ll likely encounter when you start looking into student loan bankruptcy is “undue hardship.”

As its name suggests, this is typically an unexpected situation where you find yourself in financial ruin.

Due to a significant reduction in income, you’ve found yourself to be unable to take care of your student loans.

For your bankruptcy application to be approved by the courts, undue hardship must be proven.

For most students, this means they will undergo a strenuous financial test known as the Brunner Test.

The Brunner Test

Currently, the majority of courts use this testing procedure as a way to determine a client’s ability to pay their loans.

Four main components need to be considered during this proceeding, including:

The debtor must prove they can’t maintain a standard of living if forced to pay their student loans.
A debtor must prove that their dependents cannot maintain a standard of living if the debtor pays their loans.
Extenuating circumstances will continue for the duration of the payment period, preventing loan repayment.
The debtor has shown a substantial amount of good faith regarding repaying their loans.

If your financial situation can prove the above, there’s a likelihood you can have your student loans discharged.

However, you will likely have to seek the guidance of a bankruptcy lawyer to help you through the proceedings.

Although it’s beneficial to have a legal representative, it’s an added cost to consider.

How Does Student Loan Bankruptcy Work?

Aside from meeting the conditions of the Brunner Test with substantial evidence, there’s a lot to prepare for.

The process of discharging your loans through bankruptcy can be arduous, which is why it’s often avoided.

Let’s take a look at the most common steps you’ll likely have to take.

Step 1: Find a lawyer.

The very first thing you should consider doing when thinking about bankruptcy is hiring a lawyer.

These individuals are highly trained in the legal criteria required for filing bankruptcy.

Also, they will represent you in a court of law, if necessary, which is always an added benefit.

With the help of a lawyer, you will have a clear idea of what paperwork is required for filing.

They can assist with filing the paperwork, ensuring it’s filled out accurately, and giving you your next steps.

It’s a fantastic way to have peace of mind, although it can be pretty costly.

Step 2: File bankruptcy.

With a lawyer retained for your case, the next step is to file your bankruptcy.

There isn’t a specific type of bankruptcy explicitly designated for student loans, so you’ll either file Chapter 7 or Chapter 13.

An extra step is required for student loans, known as an adversary proceeding, and it must be filed for student loan discharge.

During this process, you’ll have to provide full disclosure of your debts, income, expenses, and assets.

There’s no doubt it’s one of the most invasive components of the process, as all of your money must be accounted for.

It’s also likely you’ll be assigned a trustee who will manage your creditors to ensure your debts are accurately portrayed.

Another requirement for individuals declaring bankruptcy is to meet with a counselor.

Credit counselors can assist you with managing your finances and determining whether bankruptcy is the only option.

It’s important to remember that although it can be overwhelming and embarrassing, credit counselors are there to help.

Depending on whether you file Chapter 7 or Chapter 13 bankruptcy, the process may differ.

Let’s look at the processes involved with each.

Chapter 7

When declaring Chapter 7 bankruptcy, your designated trustee sells your assets that are declared non-exempt.

These items could include your vehicle, personal possessions, and also your home.

The trustee then uses the money from the sale of your assets to pay back your creditors.

Once your assets have been successfully liquidated, the court then discharges the rest of your debt.

This process seems simple enough, but there are extra criteria you need to meet, including:

You must not have filed Chapter 7 bankruptcy in the last eight years
Your monthly income has to be below your state’s median
You will likely have to undergo a means test
Specific debts, like alimony and child support, cannot be discharged

Chapter 13

The other alternative for bankruptcy is to file Chapter 13.

The majority of people that opt for this course are those who couldn’t pass the means test.

It’s also common for individuals who don’t want to foreclose on homes with equity in them.

Another common term for Chapter 13 is “reorganization,” as your trustee supervises your repayments.

Instead of liquidating your assets, you will create a repayment plan that uses 100% of your disposable income.

With this money, you’ll then have to repay your creditors within three to five years, depending on your case.

It’s important to note that this method doesn’t allow you to have control over your repayments.

You’ll have to rely on the bankruptcy court to determine a monthly debt repayment amount.

The majority of students that choose this option are those with private student loans.

What to Know Before Filing for Bankruptcy

For many students, there aren’t any alternatives other than filing bankruptcy.

There are several important things you should know about the process to help you get prepared.

If you’re fortunate enough to have other options, it’s better to explore those before settling on bankruptcy.

1. Loss of Control

By far, one of the most considerable challenges of filing bankruptcy is that you lose complete control of your finances.

With Chapter 7, all of your non-exempt assets are sold, and that money goes to your creditors.

With Chapter 13, the bankruptcy court determines the total amount you pay your creditors per month.

Depending on the type of debt you owe, you might incur higher interest rates, which cause higher monthly payments.

You’ll also lose the current loan term that you have with your lenders and be faced with longer terms with added interest.

2. Lowering Financial Reputation

If your lender sees you’re filing for bankruptcy, they know you are incapable of paying your loans.

For those with federal student loans, the Department of Education also notes that you could be using bankruptcy to avoid repayment.

If anything in your case suggests this is an intentional strategy to avoid repayment, your case could be denied.

Regardless of how challenging it is to repay your student loans, bankruptcy is a difficult financial situation to enter.

It should only be used by individuals who sincerely have zero alternatives for paying back what they owe.

3. Additional Expenses

You might assume that a process designed to prove you don’t have money wouldn’t cost money.

In reality, filing for bankruptcy isn’t free, and it can be quite expensive in many instances.

Not only will you be responsible for paying a lawyer, but you’ll also have court filing fees.

It is possible to have the fees waived, but your lawyer will have to petition for this to take effect.

In most cases, courts will see that you can afford to retain a lawyer, and as such, you can also afford court filing fees.

To help avoid this issue, finding a pro bono lawyer can be a great alternative to contribute to your case.

4. Credit Impacts

Another significant thing to be prepared for when filing bankruptcy is the hit your credit will take.

You’re declaring that your income isn’t significant enough to pay back what you owe by discharging your debts.

As such, it’s noted on your credit history and can prevent you from making significant life changes.

For example, it can be nearly impossible to get a mortgage, purchase a car, or even get a credit card in your name.

When you file for Chapter 7 bankruptcy, it stays on your record for up to 10 years.

Even Chapter 13, which is often looked on more favorably, stays on your credit history for up to seven years.