Student loans are a large and growing problem.According to the Federal Reserve, student loan debt totaled over $1.5 trillion as of June 2018, up from $1.15 trillion just five years earlier. Over 44 million Americans have some level of student loan debt, and 11.2% of that debt is either in default or at least 90 days delinquent.
It’s no wonder that so many people are struggling to pay bills and save for the future under the weight of their student loans.
Student loans are more difficult to discharge through bankruptcy than other types of debt, but it isn’t impossible. This article will explain how it works, the steps you need to take in order to discharge your student loans in bankruptcy and alternative strategies you should explore first.
Can you file bankruptcy on your student loans?
While it is possible to file bankruptcy on your student loans and have the debt discharged, it’s a difficult process with strict requirements that can be challenging to meet.
The baseline requirement is proving to the courts that repaying your student loans presents an “undue hardship,” a standard that is interpreted differently depending on where you live and which court happens to hear your case.
“It’s a mushy set of criteria that doesn’t lend itself to a lot of uniformity,” said Adam S. Minsky, an attorney who specializes in helping student loan borrowers. “The cases that I’ve seen come out with favorable decisions tend to be older borrowers, borrowers who have very long periods of unemployment or underemployment, and sometimes there are health issues, injuries, disabilities, things like that.”
Why your student loans are unlikely to be discharged
In the 1970s, a popular narrative began to emerge in the media about borrowers who were taking out student loans to attend college and then playing the system to get them discharged after they graduated.
There was no real data to support this claim, but in 1976, Congress acted on it anyway and passed a law that made it almost impossible to discharge federal student loans until either five years had passed since default or you were experiencing undue hardship. The waiting period was extended to seven years in 1990. In 1998, it was simplified to require undue hardship without a time element.
Then, in 2005, Congress updated the law once more to subject private student loans to the same undue hardship criteria as federal student loans.
At this point most courts, though not all, use something called the Brunner test to evaluate undue hardship.
What is the Brunner test?
The Brunner test looks at three factors to decide whether a particular borrower is facing an undue hardship.
First, you have to demonstrate that you are not able to maintain a minimum standard of living while repaying your student loans.
“This is typically the easiest one to prove,” said Jay Fleischman, a student loan lawyer. “You’re not required to be living like a pauper, but by the same token it’s presumed that you’re not going to be living a life of opulence.”
Fleischman said that while every judge interprets this standard differently, things such as paid sports for your kids, private school instead of public school and excessive cable packages may be deemed unnecessary.
Second, you must show that your situation is likely to persist for a significant portion of the repayment period through no fault of your own. That means that you can’t use your current income as an argument if there’s the opportunity to earn more elsewhere, and you can’t use extended unemployment if it either ended or is likely to end soon.
“It’s forward-looking criteria,” said Fleischman. “Courts will look at the marketability of your skills and the quality of the education you’ve received to determine your earning potential.”
Third, you must have made good faith efforts to repay your student loans prior to filing for bankruptcy.
“In some courts, for a federal student loan, that will mean that you’ve looked at one of the income-driven repayment (IDR) options,” said Fleischman. “For a private student loan, it might mean that you’ve attempted to rework your payments or tried for forbearance.”
Then there are some courts, specifically those in the 1st and 8th circuits, that don’t use the Brunner test at all.
“Some courts use what’s called ‘totality of the circumstances,’ which jettisons that three-part test in favor of looking at the totality of your situation,” said Fleischman. “It tends to be a slightly easier test but it’s not used very widely.”
At the end of the day, even when the Brunner test is used, the specific standards that need to be met to prove undue hardship are inconsistent and difficult to narrow down.
“What that test looks like and how it applies varies depending on where the borrower lives and what court they’re in,” said Minsky.
If you’re successful at proving undue hardship, the court can discharge your loans completely or grant a partial discharge. It can also simply change the terms of your loans to make them easier to pay, such as lowering the interest rate.
How to get your student loans discharged
If you believe that trying to get your student loans discharged through bankruptcy is the right move, here are the steps.
1. Hire a lawyer
While it is not absolutely necessary to hire a lawyer, Fleischman said that doing so is a good idea.
“If you’re going to file for bankruptcy to seek a discharge of those student loans, understand that it is very complicated and very skill-intensive,” said Fleischman. “An attorney will help you through that process.”
However, Fleischman also warned that you don’t get those attorney fees back if you are unsuccessful at getting your student loans discharged, which means that you need to be careful about taking on the extra expense when the odds of winning a judgment are low.
The National Consumer Law Center provides some resources to help you find an attorney.
2. File a bankruptcy case
If you do want to move forward, the next step is filing a bankruptcy case.
The Administrative Office of the U.S. Courts provides guidance on the paperwork needed to file, and it also advises that you check with your local court to see if there are other local forms you need to file.
3. File an adversary proceeding
Once your bankruptcy case is filed, you then need to file a separate lawsuit within the bankruptcy court against the lender of your student loan. This lawsuit is called an adversary proceeding and it asks the court to find that repaying your student loans would present an undue hardship.
“When you’re dealing with student loans you’re actually dealing with two separate cases, one living within the other case,” said Fleischman, explaining how the adversary proceeding acts as a separate case within the broader bankruptcy case.
You must file a complaint in order to initiate an adversary proceeding. This complaint identifies the court in which it’s being filed, the parties to the complaint, a summary of the situation and reason for the complaint, and the specific relief you are seeking from the court.
The National Consumer Law Center provides a sample of what this complaint could look like.
4. Go through discovery
Discovery is the process of gathering evidence and exchanging information between parties to the lawsuit. It can be complicated, and it is one area where having an attorney can be a big benefit.
“Once you’ve filed the case with a summons and complaint, the lender has the opportunity to answer and to conduct discovery, as do you,” said Fleishman. “This could involve the exchange of documentary information, depositions, expert testimony and the like.”
It’s also worth noting that this process can be time-consuming and expensive. The National Consumer Law Center estimates that the entire litigation process can require a total of 40 to 100 hours, and according to Fleischman, you can expect to pay anywhere from $4,000 to $15,000, on top of attorney fees.
5. Proceed to trial and judgment
After discovery, the case goes to trial, evidence is presented from both sides, and the judge eventually makes a decision.
If you are not awarded a discharge, Fleischman said that you are allowed to appeal. But doing so is both rare and likely unsuccessful.
5 alternative ways to deal with your student loan debt
While bankruptcy can be an effective tool, and in some cases the best way to get out from under the weight of your student loans, it generally shouldn’t be your first option.
Here are five alternative approaches to consider before filing for bankruptcy.
1. Revisit your budget and spending habits
Given that you’ll have to prove to the court that your income isn’t enough to meet your expenses, it makes sense first to take a close look at your budget and figure out if there are any changes you can make that would help you afford your student loan payments.
“I always tell my clients to first look at their spending and determine where their money leaks are and try to plug those leaks,” said Fleischman. “Determine where your expenses can be reduced and start there.”
2. Consider IDR
If you have federal student loans, you may be eligible for IDR, in which your monthly payment is adjusted according to your income and family size. The less you make and the bigger your family is, the less you’ll have to pay.
There are downsides to IDR, such as the fact that you may end up paying more interest over time and that it may take longer to get out of debt. But if you’re truly unable to afford your monthly payment, those downsides may be worth the immediate relief.
3. Work toward loan forgiveness
One of the additional benefits of IDR plans is that they can eventually lead to loan forgiveness.
If you work for the government or a qualifying nonprofit, you may be eligible for Public Service Loan Forgiveness, which forgives your student loan debt tax-free after 10 years of eligible payments.
Otherwise, you may be eligible for forgiveness after 20 to 25 years, depending on the type of IDR plan in which you enroll. The amount forgiven would be taxable, but it could still provide significant relief.
4. Consider refinancing private student loans
Refinancing your private student loans could allow you to secure a lower interest rate and extend your repayment period, either of which could lower your monthly payment.
“You need to be careful about it because you want to make sure that you’re actually saving money instead of spending more,” said Fleischman. “But this may be a situation in which refinancing makes sense.”
Fleischman did warn against refinancing federal student loans, primarily because of the protections offered by the federal government. These protections are lost in refinancing.
5. Strategic default and settlement
In some cases, Fleischman argued, it might be a good idea to strategically default on private student loans in order to create a settlement opportunity.
“Settlement of any debt is seldom an option when you are paying the debt according to the terms and conditions of the loan,” said Fleischman. “It’s just not the way that business is transacted. In those situations, a strategic default may make some sense.”
Fleischman warned that there are negative consequences to default, such as the impact on your credit score, the collection actions that would be taken against you and the fact that there is no guarantee that you will be able to settle at all, nevermind along favorable terms.
But if you’re hoping for a settlement instead of entering bankruptcy, defaulting may be the best way to create that opportunity.
Proceed with caution
At the end of the day, the reality is that discharging your student loans through bankruptcy is a difficult and unlikely proposition.
That doesn’t mean that it should always be avoided, as there are situations in which it’s the right move. You just need to go into the process with your eyes wide open.
“Make sure that you investigate all of your other options first,” said Fleischman. “And if you are going into bankruptcy, make sure you understand completely what you’re getting into and that you have a realistic sense of what your opportunity for success is going to be.”