As the price of a college education continues to skyrocket, more and more students are graduating with staggering debt loads. Even minimum monthly payments can be difficult to manage, forcing new graduates to put off buying a home or starting a family. Discharging student loans in bankruptcy is extremely difficult, but not always impossible. Here is what you should know.
As a general rule, student loans are not dischargeable in a Chapter 7 bankruptcy. This means that after your bankruptcy is finalized, you will still be on the hook for your loans. The silver lining, though, is that most other types of unsecured debt are dischargeable. Many people find that they are better able to manage their student loans once their other debts are wiped away.
Student loans are generally not dischargeable as part of a Chapter 13 bankruptcy. However, filing for this type of bankruptcy can help you get your payments under control. The reasons lie in the way that a Chapter 13 bankruptcy is structured.
Unlike a Chapter 7 bankruptcy, a Chapter 13 is not a simple wiping out of your unsecured debts. Instead, it creates a payment plan that can last for as long as five years. Your payment plan depends on a formula based on your disposable income, but the net result is that low-income borrowers often end up paying very little each month. At the end of your payment plan, the bulk of your debts are forgiven, though not your student loans.
However, Chapter 13 grants an automatic stay from collection activities, which means that the bank cannot try to collect on your debts, including your student loans, for the duration of your payment plan. During your repayment period, your student loans are considered nonpriority unsecured debts. This means that during the Chapter Bankruptcy, the student loans are treated the same as other nonpriority unsecured creditors such as credit card companies.
You will have to resume student loan payments after your bankruptcy is finalized. However, it will be three to five years further into your career, and possibly earning a higher income. In addition, your other nonpriority unsecured debts will be gone, freeing up money each month to put toward your loans.
Bankruptcy law contains a provision for discharging student loans if they create an undue hardship on the borrower. However, proving undue hardship is extremely difficult. The most commonly used test is known as the Brunner Test, and borrowers must meet all three factors:
- Poverty: You must prove that if you repay your loans, you will not be able to maintain a minimum standard of living for yourself and your dependents.
- Persistence: You must prove that your circumstances are likely to last for the majority of the repayment period.
- Good faith: You must prove that you have made a good faith effort to repay your loans, including taking advantage of the various deferment, forbearance, or payment plan options.
The Brunner Test is not a requirement, and some courts use other methods to determine hardship. Regardless of which method is used, however, courts are reluctant to permit discharges based on undue hardship. Occasionally, people working in “worthwhile careers” that are low-paying receive this type of discharge, but it is most often reserved for those who have serious, life-altering disabilities, or whose children require substantial care such as for disability.
Although discharging your student loans in bankruptcy is nearly impossible, you do have other options. Income based and income contingent repayment plans are among the most popular.
To qualify for income based repayment, you must have a partial financial hardship at the time you enter the program. Proving this is significantly easier than meeting the undue hardship test for discharging your loans in bankruptcy. You may remain in the program in subsequent years even if you no longer have a partial financial hardship. This program requires you to pay 15% of your monthly discretionary income toward your student loans, calculated on an annual basis. At the end of 25 years, the remainder of your loans are forgiven.
Income contingent repayment is similar, but there is no partial financial hardship requirement. Under this program, you must pay 20% of your discretionary income toward your student loans. Your remaining loan balances are forgiven after 25 years.
While it is worth asking your bankruptcy attorney if undue hardship is an option for you, only the most extreme cases qualify for bankruptcy discharge of student loans. However, there is help through your lending institution. Contact your student loan holder to find out if an income sensitive repayment plan or another option is right for you.
If you have questions on wiping out or discharging student loans or any other type of debt call The Law Offices of David M. Offen today at (215) 625-9600 to schedule your free initial consultation. We’re here to help you on every step of the way.