When it comes to student loans under Chapters 7 and 13 of bankruptcy law, it is possible to partially or completely discharge your student debt. However, there is a rigorous process to go through first and the chances of full debt forgiveness are small.
The first thing to do is figure out if you qualify for “undue hardship” and file an adversary proceeding. After that, the courts will look at several factors and judge your case on two main tests to decide if you’ll need to pay all, any, or none of your student debt.
Would the Debt Cause You Undue Hardship?
Before you file for bankruptcy as a means to discharge your student loans, you need to know if you even qualify. In the current legal system, you need to be able to prove that paying back your student loans would cause you “undue hardship.”
The bad news is that this same legal system doesn’t define or explicitly state what “undue hardship” is, so the courts are forced to use tests to examine your life and determine if you qualify.
Your best option is to schedule an appointment with a bankruptcy lawyer and layout your financial situation. The lawyer will be able to tell you if you might qualify, but the courts will inevitably have the final say.
How to Prepare and File an Adversary Proceeding
It’s important to understand that, of the people that attempt to discharge their student loans through bankruptcy, most of the cases are rejected or only granted a partial discharge. But it’s not as simple as just filing bankruptcy.
An adversary proceeding is a secondary filing within bankruptcy that many people fail to file, but the lender will have a chance to dispute the claim. Because of this, you need to go to court with evidence prepared.
Most of the information will be common sense—your income, living expenses, and total cost of your debt. That income-to-debt ratio will be a big factor in your favor, but you have one other card to play.
You can contact your lender and explain your situation to lower or postpone the debt repayment. If they work with you, you might not need to move forward with the filing, but if they don’t make sure you keep records of every communication and document—more information here.
The Brunner Test is used more often by the courts in adversary proceedings because it’s more definitive. With this test you have to be able to prove 3 main things, which is why documenting evidence beforehand is so important.
- First, you need to convince the court that you can’t afford basic standards of living for you and any dependents while paying off your student loans. This is mostly the income-debt ratio mentioned earlier, where the debt seriously impedes your day-to-day living conditions.
- Second, you have to prove that the financial situation you’re in will persist for the majority of the time you’ll be repaying your debts. This means that if your period of repayment is a year, more than half of that time will be spent at the same job with the same expenses. With this one, you might also want to have a reason that you can’t get a higher-income job. It can be about the hours you’re available, a disability, or lack of transportation. The better your argument, the higher your chances of success.
- The third and final point under the Brunner test is that you’ve made an effort of “good faith” to repay your debts.
Totality of Circumstances
The other, less common test that courts have at their disposal is to examine your totality of circumstances. This means they consider your financial situation, cost of living, and other factors that affect you negatively due to the student loans.
These are pretty self-explanatory and similar to the Brunner test, though the totality of circumstances looks at all factors rather than specifically the three under the Brunner test.
For example, totality of circumstances looks at everything affecting or preventing your financial situation from improving, whereas the Brunner test specifically asks if your situation could improve in any way during the repayment process.
Totality also looks at a reasonable cost of living, basing that number off on statistics, location, and demographics. Again, this test is far less commonly used regarding bankruptcy because of its loosely defined nature.
Which Chapter Should I File Under?
When you file an adversary proceeding, you must know which chapter to file under 7 or 13. If you hire a lawyer, they will probably advise you which way to go but it’s still good to understand both.
One important note is that politicians have been making ground on reform acts to specify undue hardship better and make it easier to file and be approved for student loan discharge, but it is slow progress.
Which chapter you file depends largely on your goal, so decide beforehand if you need as much of your debt as possible discharged or simply restructured because that’s the biggest difference in the outcomes.
With that said, a Chapter 7 filing generally takes around 4 months for the entire process. The good news is that this filing is aimed at eliminating any excess or extraneous debts, but there is no guarantee that your student loans will be discharged.
A Chapter 13 filing is similar with different numbers, for the most part. The process here can take up to 6 months to go through, followed by a maximum of 5 years to repay your debt. The reason for the 5 years is the same as deciding on your goal: restructured debt.
While a Chapter 7 filing seeks to wipe out your debts and, hopefully, student loans, Chapter 13 filings restructure your debt and you will have to pay at least some of it. If your student loans qualify, they will be lessened and that number will be added to the resulting debt repayment.
Again, which chapter you file under to erase or lessen your student loans is up to you. Each one has pros and cons, with one seeking to give a clean slate while the other wants to lower the final number.
It’s important to know, however, that Chapter 13 filing will be viewed better on your credit history and has a higher approval rate than people who file for a Chapter 7 proceeding.
What are the Possible Outcomes?
Whichever chapter you file your adversary proceeding under, the court will inevitably conduct one of the tests discussed above and conclude. The potential results are a full discharge, partial discharge, or a complete rejection of your case.
This is by far the best outcome that you could hope for if you’re struggling because a full discharge means complete student loan forgiveness. There have been cases where hundreds of thousands of dollars were wiped clean, but it’s not common.
Obtaining a partial discharge of your student loans and other debts is still a good thing. While not a clean slate, you’ll only have to pay a fraction of the total debt after they’ve restructured the total amounts.
The other good thing about a partial discharge is that you’ll probably get a better interest rate and payment option that will fit your income, making it easier for you or your family.
Rejection of Discharge
This one is simple: the court denies your filing and forces you to continue the repayment process. The worst part is that the bankruptcy filing remains on your credit, so you want to avoid this at all costs.
What Else Can You Do?
While it is possible to file a Chapter 7 or 13 adversary proceeding under bankruptcy to remove your student loans, it should be your absolute last option. Not only will it seriously damage your credit for years, but it’s a lot of stress, so it’s best to try and avoid it altogether.
Many lenders will work with you through a hardship program or payment adjustment because they know something is better than nothing. Other than that, you have the option of income-based repayment.
There are 4 active repayment plans, but the basic concept is that if you qualify for one then the company in charge of your federal loans will extend how long your repayment is to a maximum of 25 years. The revised payments will be based on a percentage of your income.
Not only will this lower your monthly payments and give you room to breathe, but the best news is that many people qualify for at least one of the repayment plans. Even better is that you avoid the credit hit of filing for bankruptcy!
You have to have extenuating circumstances to qualify for these, such as job loss or an injury, but every federal loan is open deferment or forbearance. There are a few differences between the two, so here’s what to know.
Deferment essentially puts off all debt payments for a short time. The amount of time is likely based on the loan amount or your financial situation, but your debt will cease to collect interest during this time as well.
Similar to deferment, forbearance will provide a brief window of time to get back on your feet. However, forbearance can only last for a year and during those months your interest will continue to build. After the forbearance period, you’ll be expected to pay that interest.
In either of these cases, it is important to know that not every lender offers these options. While the federal loans do, other debtors don’t have to follow the same mandates. Some don’t have either and some will give forbearance with the stipulation that you pay the monthly interest.
Before you file for loan discharge because of a disability, it is important to know this is only on the table for some federal loans. Many lenders don’t even offer a disability discharge, but might be willing to restructure your repayment.
However, if your loan is one of those you might be qualified for a complete student loan discharge if you can prove “total and permanent disability discharge.” This means that your recent disability prevents you from earning an income or paying your debts.
While unfortunate, this will avoid having to file for bankruptcy and remove student loans and many other debts. If you’ve been injured since your loans, be sure to check if you qualify.