Bankruptcy and Student Loan Discharge
If you're having extreme difficulty repaying your government backed student loans, you're not alone. The default rate of student loan borrowers on their higher education loans is about 10%.
But you don't have to slide into default - you may be able to discharge student loans with a bankruptcy.
Defaulting on Government Backed Student Loans
What happens if you never pay your student loans? A lot. The serious side effects of defaulting on United States government-backed student loans include these:
- The entire unpaid balance of your loan becomes due.
- You become ineligible for loan deferment, forbearance, and other benefits like alternative repayment plans.
- You lose eligibility for additional federal student aid.
- A serious delinquency is reported to credit bureaus and reflected in your credit history and scores.
- You may not be able to purchase or sell real estate.
- Your tax refunds and federal benefit payments may be withheld.
- Your wages may be garnished.
- You can be sued and charged court costs, interest payments, collection costs, attorney's fees, and other fees.
- Your school may withhold your academic transcript.
These consequences are very harsh, and many believe that there is no way to get out of federal student loans. But if you qualify, you can discharge at least part of them in bankruptcy.
How to Discharge Federal Education Loans in Bankruptcy
Many people, even lawyers, don't know that you can actually discharge government-backed student loans in bankruptcy.
While private student loans can be written off fairly easily, bankruptcy law makes it more difficult to erase taxpayer-supported education debt.
However, it is harder to do this than to wipe out most other loans. You must prove that paying your student loan will cause you and your family undue hardship.
In most jurisdictions, "undue hardship" means that you can't maintain a minimal standard of living and pay your student loans.
Your inability to repay your student loans has to be a long-term situation. You must have made a good-faith attempt to repay them.
What is a Minimal Standard of Living?
A minimal standard of living in modern American society, according to many courts, includes these elements:
- Safe, clean shelter
- Basic utilities, water and telephones, and internet
- Decent clothing and footwear, personal hygiene products, health insurance, medical and dental care
- Transportation - either public or a personal vehicle
- Small diversions or recreation - watching television, keeping a pet
You must expect to make some personal and financial sacrifices in order to repay your debt.
Many courts have denied undue hardship discharges when they believed that the debtor's expenses were excessive. Examples of excessive include an "unnecessarily large" home, eating out "too frequently in restaurants" or spending on non-essential items like recreational boats.
Courts vary in their treatment of some expenses. Most, but not all, consider the cost of cigarettes, contributions to retirement accounts, tithing to churches and supporting independent family members to be non-essential.
Definition of "Future Inability to Repay"
The second component of undue hardship is your ability to repay the student debt in the future.
The courts generally consider your current income, your earning capacity and also, in many jurisdictions, your spouse's income. You have a better chance of qualifying for undue hardship if any of these conditions apply:
- Your situation changed since applying for the student loans - for instance, you or a dependent experienced a medical condition or disability impacting your ability to pay your bills.
- Your education, due to its extent or quality, restricts your earning potential - this might be the result of failure to complete the education for which you acquired the student debt.
- You lack marketable job skills or are at the top of your wage scale.
- Your age makes it unlikely that you have enough earning years to repay student debt.
The courts will consider whether you could earn more outside your chosen field as well as opportunities for retraining or relocating to improve your ability to pay your loan.
You cannot use the fact that the career for which you trained doesn't pay well.
Their ruling: "These courts have likewise ruled that a debtor is not entitled to an undue-hardship discharge by virtue of selecting an education that failed to return economic rewards."
Even if your college misled you about the value of your education - or committed fraud - this won't necessarily get your government student loans written off in bankruptcy court. Some courts do consider this as a factor while others have ruled that they will not because it does not punish the schools - only taxpayers.
What is a Good-Faith Attempt to Repay?
The final leg of an undue-hardship claim is that you have attempted to repay your student loans and are simply unable to continue.
Most courts agree that you can demonstrate good faith by attempting to obtain employment, maximize your income, and minimize expenses. You should make payments when you can.
"In determining whether a debtor has made a good faith effort to repay a student loan obligation," say the courts, "a primary consideration is whether the debtor actually made any payments on the obligation and, if so, the total amount of payments."
Courts also look at the amount of time that has passed since graduation and the efforts you made to pay your loan - perhaps by negotiating an affordable repayment plan.
Some courts examine the length of time between when the loan first became due and when you seek to discharge it. The less time that has passed since the student loan first became due, the less likely it is that a court will find that you are acting in good faith.
Who Gets a Federal Student Loan Bankruptcy Discharge?
Situations that are unlikely to get you relief in bankruptcy from student loans include:
- You are not working up to your full earning potential
A medical graduate cannot, for example, take a low-paying retail job just to discharge her student loans and then pursue the lucrative medical career. An art history grad cannot seek relief because of low pay or job scarcity when he could work full time in another field and honor his obligations.
- You did not explore an income-based repayment plan
You could afford your loan payments if you pursued an income-based repayment plan, which limits your payment to 10% or 15% of your disposable income and writes off your remaining balance after 25 years.
- You have not made a credible attempt to minimize your expenses
If you have expensive hobbies, an upscale home or more than basic transportation, courts are unlikely to be sympathetic to you.
Situations that are more likely to result in discharge:
- Advanced age
Your age makes it unlikely that you'll advance in your career to the point that you'll be able to repay your loans.
Your situation changed after taking out your student loans, impacting your ability to graduate or earn what you expected - for instance, an auto accident causes you to become disabled, or a dependent incurred significant medical expenses.
- Good-faith effort
Your standard of living is very lean, you have little or no disposable income with which to make payments, and there is little reason to expect a significant increase in earnings during your career. You have made payments when possible and sought income-based repayment plans.
Even if you can't clear your student loans through bankruptcy, discharging your non-student debt might be enough to help you afford your payments - especially if you can take advantage of one of the alternatives listed below.
Alternatives to Discharging Government Guaranteed Loans
If you don't qualify under undue-hardship provisions, you can request an income-driven repayment plan. The federal government says that, if your income is low enough, your plan payment could be as low as zero. Your payment may be set at 10% to 20% of your discretionary income. After 20 or 25 years of payments, any remaining balance can be forgiven.
You can compare the different plans offered and estimate your monthly payment with this Federal Student Aid Loan Simulator. You answer questions about your income, the amount and interest rate of your student loans, and expenses like retirement savings and medical insurance premiums.
Student loan forbearance and deferral
If you're having difficulty paying your student loans, you can contact your loan servicer and request a forbearance or deferral. These options allow you to stop paying your student loans for a limited time. Use that time to clear other debt, seek better-paying work, or perhaps retrain or relocate to find better opportunities.
Student loan forgiveness
You may be able to have your student loan balances forgiven. Professionals in public service, teaching and medicine can often get their loans forgiven by practicing in underserved areas. Another option is finding an employer offering student-loan relief as a benefit.
Student loan consolidation
Look into student loan consolidation. You might be able to reduce your monthly payments by reducing your interest rate, extending your repayment, or both.
How to Adjust Your Finances to Pay Student Loan Debt
Finally, get creative. List ten ways you can cut expenses right now and ways to make more money. For instance:
- Get a roommate
- Cancel your cable and choose less-costly online entertainment
- Switch to a less-expensive phone and data plan
- Sell your fancy phone and buy a used one
- Get rid of your gym membership and take up running or home-based workouts
- Go meatless one or more days a week
- Shop your auto and home insurance policies
- Refinance your house and wrap in your student loan balance
- Get a cheaper apartment
- Take a part-time job
- Start an eBay business
- Sell your car and take public transportation
- Consider trade school to bump your pay potential
Obviously, the list will differ depending on your location, resources and priorities. Student loan repayment can be a challenge. If your degree was too costly for the financial benefit it delivered, look for ways to make it pay. The worst thing you can do is nothing, because student loan default will never stop haunting you.