Student Loan Bankruptcy: Is It A Good Idea Or Should You Try The Alternatives?
Around 44 million Americans owe nearly $1.75 trillion in student loan debt, an increase from $481 billion in 2006, the world's highest level of student debt. Student loan debt can be overwhelming, and figuring out how to manage it can be difficult.
For some, filing for student loan bankruptcy may appear to be a viable option. However, before making any decisions, it is critical to understand the complexities and difficulties associated with this process.
Here is a look at student loan bankruptcy and other options for dealing with student loan debt.
Can You Get Out of Student Loans Through Bankruptcy?
Bankruptcy does not automatically eliminate student loan debt. Chapter 7 or 13 bankruptcy can discharge some consumer debts, but student loans are not included.
Discharging a debtor's student loan through bankruptcy requires a separate and expensive process with strict standards and is only possible for those in exceptional circumstances.
To get a student loan discharge in bankruptcy, you must show that repaying the loans would cause significant hardship for you and your family. It is up to the courts to determine if you are eligible. The Brunner Test is used by most, but not all, federal courts of appeal to assess hardship.
The Brunner Test, used by many federal appeals courts to evaluate hardship, is comprised of three main points outlined by the Federal Student Aid office of the U.S. Department of Education: the inability to maintain a basic standard of living while repaying loans, proof that the hardship will persist for a significant portion of the repayment period, and an honest effort to repay the loans before seeking discharge through bankruptcy.
How the Biden Administration Has Made Student Loan Discharge in Bankruptcy Easier
The Biden administration has made it easier for struggling borrowers to discharge federal student loan debt in bankruptcy.
The Department of Justice and Education announced a new process on Nov. 17, 2022, to help borrowers get relief and reduce time-consuming investigations.
Borrowers seeking to erase their debt will fill out a 15-page form, which will be processed and evaluated by the DOE and DOJ using prescribed standards. Government attorneys will use the form to recommend to the bankruptcy court for each discharge request.
The new process aims to make it easier for the government to identify cases where discharge is appropriate and reduce scrutiny. Its effectiveness is still uncertain, as it will depend on how the Departments of Education and Justice implement it.
Discharging Student Loans in Bankruptcy Is Difficult
Credit card debt, personal loans, auto loans, and mortgages are much easier to discharge in bankruptcy than student loans. The United States Bankruptcy Code classifies student loans alongside child support obligations, taxes, and criminal fines.
Because federal student loan borrowers have access to income-driven repayment plans, federal student loans are much more difficult to discharge in bankruptcy than private student loans.
"It is possible to use bankruptcy as a tool for student loan forgiveness. Aside from the hassle of filing for consumer bankruptcy, student loans are generally not dischargeable through bankruptcy unless the borrower can prove that repaying the loans would cause an undue hardship," said Paw Vej, COO of Financer. "This is a very high standard to meet and is difficult to do since there is no standard for what qualifies as undue hardship."
Unless you're extremely elderly or unable to work due to a disability, you'll have difficulty convincing a court that your financial situation is unlikely to change in the future. Furthermore, the courts may not agree with you about what a "reasonable standard of living" means.
In other words, many of the above criteria are subjective, and bankruptcy courts aren't prone to absolving student loan borrowers. As a result, student debt is rarely dischargeable in bankruptcy.
But "if you qualify due to financial hardship caused by your student loans, then filing for bankruptcy could help reduce or eliminate your debt," said Johannes Larsson, Founder and CEO of JohannesLarsson.com.
"Before filing for bankruptcy, make sure to research the available options and determine whether student loan forgiveness is something that would benefit you," added Larsson.
Statute of Limitations on Student loan
The statute of limitations is the amount of time a debt collector has to file a lawsuit against someone over a debt. This time limit helps protect debtors from being responsible for their debts forever.
The statute of limitations can vary based on the state where the loan was taken out, the current state where you live, or a different state specified in the loan contract.
It's important to note that federal student loans do not have a statute of limitations, which means that the loan holder can sue you at any time to make you pay. However, private student loans have a statute of limitations that can range from three to 20 years, depending on the state.
When researching the statute of limitations for private student loans in your state, it's important to find the specific length for these loans. This information can help you better understand your rights and responsibilities regarding debt collection.
Better Alternatives for Student Loan Debt Relief
Income-driven Repayment Plans
If your student loan debt is high compared to your income, Income-Driven Repayment (IDR) plans can make it easier for you to pay back your loans. These plans are based on your income, family size, state of residence, and type of federal student loan.
There are several IDR plans to choose from, including Income-Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), and Income-Contingent Repayment (ICR).
To qualify for an IDR plan, you'll need to complete a request form on StudentAid.gov and provide some personal information. You'll have to recertify yearly to keep your monthly payments at the lowest possible amount. If your income, family size, or state of residence changes, your monthly payment will also change.
The IDR plan you qualify for will depend on your specific loan type and situation. If you recertify annually and meet the eligibility requirements, you could have lower monthly payments for up to 25 years, and any remaining balance may be forgiven.
It's important to note that IDR plans usually extend the payment period, so you may pay more interest over your loan. However, they can provide a more manageable way to pay back your loans based on your income.
Refinancing student loans means obtaining a new loan to repay existing loans at a lower interest rate. This results in switching your loans to a different lender, who will pay off your outstanding balance and interest. Afterward, payments will be made to the new lender until the loan is fully repaid.
Refinancing your student loans could be a good option if you want to release a cosigner from your loans, have a credit score of 650 or higher and want to reduce your interest rate and save money, want to simplify your monthly payments by bundling multiple student loans into one payment, want to move your loans to a different company, or want a lower monthly payment.
Public Service Loan Forgiveness
Public Service Loan Forgiveness is a program that forgives federal student loans after 120 payments, i.e., 10 years, while working for a qualifying public service employer such as government agencies, the U.S. military, or non-profit organizations providing certain public services.
Only Direct Loans are eligible for forgiveness. Borrowers with other federal loans can consolidate them into a Direct Consolidation Loan to qualify.
To pursue PSLF, you must enroll in a qualifying payment plan, such as an income-driven repayment plan, and confirm your employment in public service.
Teacher Loan Forgiveness
The Teacher Loan Forgiveness Program offers relief to teachers who have taken out federal loans. To qualify for the program, a teacher must meet the following criteria:
- Teach full-time for five consecutive academic years at a low-income school.
- Owe Direct and/or Stafford loans.
- Have a bachelor's degree and full state certification as a teacher.
The Teacher Loan Forgiveness Program can forgive up to $17,500 in student loans. However, the exact amount depends on the subject you teach. So, compared to the Public Service Loan Forgiveness program, which does not limit how much debt can be forgiven, the Teacher Loan Forgiveness program may seem favorable.
Total and Permanent Disability Discharge
Total and Permanent Disability Discharge (TPD) is a student loan forgiveness option for individuals unable to work due to a permanent disability.
If approved, TPD forgives the remaining balance of a borrower's federal student loans, including the principal and interest. To be eligible, a borrower must provide documentation from a physician certifying their total and permanent disability, and the disability must be expected to last throughout the borrower's lifetime.
TPD discharge is a one-time opportunity, and borrowers must reapply if their disability status changes. It is important to note that TPD discharge only applies to federal student loans and does not cover private student loans.
The Bottom Line
While filing for student loan bankruptcy may seem like a tempting option to get rid of student loan debt, it is a complicated process with no guaranteed outcome.
Before considering bankruptcy for your student loan debt, consider alternative options such as income-driven repayment plans, loan consolidation, and loan refinancing.
It is important to thoroughly research and understand all available options to make an informed decision on managing your student loan debt.