The public perception that you can’t discharge (wipe out) student loans in a bankruptcy case isn’t correct—but it's not easy, either. Educational loans (including government guaranteed loans and those made by private lenders) aren’t dischargeable unless paying them will cause the debtor (and dependents) “undue hardship.” Among other things, you must demonstrate to the court that you can’t make payments now and in the foreseeable future.
In most courts, you’ll have to meet the Brunner test to discharge your student loans. Each case is very fact specific, and, short of suffering a severe and permanent disability that virtually prevents you from earning an income, you're not likely to get a favorable outcome from a court that applies the Brunner test.
The three conditions that you’ll have to prove are as follows:
The high standard discourages many people from taking the steps necessary to ask the court to discharge student loans. In recent years, however, a few courts have expressly rejected the Brunner test noting that it calls for a “certainty of hopelessness” that they say isn’t required by bankruptcy law. Instead, these courts favor a more lenient “totality of the circumstances” test that recognizes the fresh start goals of the bankruptcy process.
If you can't discharge student loans, you may be able to use bankruptcy to manage the high payments.
If you qualify for this chapter, you’ll be able to wipe out unsecured debt balances for obligations like credit cards, medical bills, and personal loans without paying anything back to your creditors. Doing so should help free up money that you can use to pay your student loan payment.
(Find out more in What Is a Chapter 7 Bankruptcy?)
A Chapter 13 case can help you reduce high student loan payments to something more affordable during your plan period. Also, at the end of the case, other debts will likely be discharged (depending on the type of bills that you have), allowing you more funds in which to make the student loan payment.
In a Chapter 13 bankruptcy, you pay into a repayment plan that lasts from three to five years. It’s often used to catch up past due house payments, car payments, child support, and income taxes, or when the debtor has enough disposable income to make a meaningful payment to unsecured creditors (in that case, the debtor wouldn’t qualify for Chapter 7 bankruptcy).
While you’re in Chapter 13 bankruptcy, you’re not required to pay off your unsecured debt over a three- to five-year plan or even pay your regular monthly payment. Instead, your disposable income—the amount left over after you pay your reasonable and necessary expenses and certain required payments (such as taxes and domestic support obligations—gets divided among remaining creditors. At the end of your plan period, most unpaid unsecured debts get discharged. You’ll continue to owe your outstanding student loan balance.
Example. Hannah has a $75,000 student loan plus $25,000 in other unsecured debt when she files a Chapter 13 bankruptcy. She proposes a plan to pay her disposable income of $430 per month for 60 months. After procedural fees, the unsecured creditors will share about $400 per month. Because the student loan creditor is owed 75% of Hannah’s debt, that creditor will receive $300 per month. She won’t pay off any of her creditors in her plan. However, in most cases, all of her remaining unsecured debts, other than her student loan, will be forgiven. She’ll still be responsible for the outstanding student loan balance.
(Learn more in An Overview of Chapter 13 Bankruptcy.)
If bankruptcy doesn’t align with your goals or your financial circumstances, you might want to consider one of the programs for government backed loans developed by the federal Department of Education designed to make student loan repayment more affordable.
Your income will be taken into account when assessing your payment, and, if low enough, could result in no payment at all. Unpaid principal and interest get capitalized, but any balance will be forgiven after 20 to 25 years of participation. (It’s important to be aware of the potential tax consequences of being taxed on the forgiven balance.)
Applicants must establish eligibility yearly so that payments can be adjusted to reflect the current income. Many private lenders have repayment programs, as well.