Contrary to news reports, there are times when you can wipe out student loans in a bankruptcy case.
To do so, you’re required to not only file for bankruptcy but also to file a separate lawsuit and prove that the debt amounts to an undue hardship. If you can meet the standard required under the bankruptcy laws then you will be able to wipe out your student loan obligations – but if you fail then you’re going to walk out of bankruptcy saddled with the same bills as when you walked in.
It’s a gray area at best, with courts split on the way to address the standards set by the law.
This uncertainty is the student loan industry’s most powerful tool, making people believe they shouldn’t bother trying to discharge their student loans in bankruptcy.
In some situation, you can be reasonably sure bankruptcy won’t help with your student loan problems.
But that’s not always the case.
Instead of being bullied by student loan companies into dismissing bankruptcy as a solution, weigh the risks and reward to make an informed choice.
The Law on Discharging Student Loans in Bankruptcy
The law says that bankruptcy won’t discharge you from a student loan unless the court finds that the student loan would impose an undue hardship on you and your dependents. In the context of bankruptcy, a student loan means any of the following:
- an educational benefit overpayment or loan made, insured, or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or
- an obligation to repay funds received as an educational benefit, scholarship, or stipend; or any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual.
In my experience, qualifying for an undue hardship discharge of student loans in bankruptcy isn’t easy. The law doesn’t define what undue hardship means, so it’s up to the judge. Many courts use what’s called the Brunner Test, and others look at the totality of your circumstances. Either way, you’ve to prove that you meet the legal standard and battle the student loan lender.
Your student loan lender can (and usually will) argue against discharging your student loans. The bankruptcy judge may not be fond of letting people walk away from student loans in bankruptcy. Or he may not buy your argument.
With that in mind, here are the five times when you shouldn’t try to go file for bankruptcy to wipe out your Federal student loans.
When Bankruptcy Is A Bad Move for Student Loan Relief
You shouldn’t try to discharge your student loans in bankruptcy if:
The only loans you have are your student loans. If the student loans are all you have, then losing the student loan discharge case means you wouldn’t get any benefit from the bankruptcy at all.
You have other non-bankruptcy ways of discharging the loan. Federal student loans can be discharged or forgiven in a variety of situations that have nothing to do with bankruptcy. Those procedures are easier than pursuing a bankruptcy discharge and are handled without the uncertainty that comes with bankruptcy.
You may qualify for Public Service Loan Forgiveness. Under PSLF, the unpaid balance on your Federal student loans is forgiven after 120 timely monthly payments. The forgiveness under PSLF is tax-free and is an administrative manner handled without getting a judge involved.
You’d be able to pay the student loans if you wiped out the other debts in bankruptcy. Under any interpretation of undue hardship, you’ve got to be unable to repay the student loan and continue to support yourself and your dependents. If discharging your other debts in bankruptcy will enable you to pay the student loans, then your argument for undue hardship falls apart.
You’re retired, receive income only from Social Security retirement, and have no assets to protect. The Federal government can take your tax refunds, garnish your paycheck, and sue you to collect a defaulted student loan. A private student loan lender can file a lawsuit but can put a lien on your property and start a wage garnishment only if it gets a judgment. If you’ve got no income and no property then there’s nothing to seize. If your Social Security income is retirement-based rather than disability-based, then the government can’t take your money. Getting a discharge of your student loans in bankruptcy won’t give you any benefit, so it doesn’t make financial sense to pursue that remedy.
Analyze Your Situation Before Seeking Student Loan Discharge
I talk with clients every week about using bankruptcy for their student loans. Often, they come to me after they’ve spoken with a bankruptcy attorney who doesn’t have an understanding of student loan law.
Those clients are frustrated and looking for someone to represent them. They didn’t get a straight answer from the other bankruptcy attorneys, some of whom would have filed the case but only with a hefty legal fee and a pessimistic attitude.
Many of these lawyers have bought into the lie that bankruptcy is never going to wipe out student loans, bullied by student loan companies into submission.
Sometimes it makes sense to pay the legal fee and try to wipe out the student loan, but there’s no way of knowing for sure without a complete understanding of the issues.
You need to look at your entire financial situation, determine your other options for solving your student loan problem, and move on from there.
That’s why I look at every issue and consider each alternative before making a recommendation to a client. Every bankruptcy lawyer with student loan knowledge would do the same for you, just as every attorney who practices in bankruptcy court would engage in a complete analysis of your alternatives if you were struggling with excessive tax debts or a foreclosure.
It’s part of the process of deciding which option is best for you, and how to best structure a solution to your student loan problems.