You have $150,000 in student loan debt and your annual income is $30,000. You don't see a way you can pay off your loans. You think about bankruptcy, but you've heard the qualifications are pretty steep to discharge student loans. How do you know if bankruptcy is an option for you? And if it isn't, do you have any options for managing seemingly insurmountable debt? (For more, see Declaring Bankruptcy Is No Easy Out.)
Who Can Discharge Student Loans in Bankruptcy
To discharge student loans in any bankruptcy filing, you need to prove "undue hardship." What does undue hardship mean in non-legal terms? According to bankruptcy judge John Ninfo, you or your dependent has to have a mental or physical condition that prevents you from working. Just not being able to afford your payments doesn't cut it.
The hefty standard most judges go by comes from a 1987 court case, Brunner v. New York State Higher Education Services Corp.
The Brunner test most bankruptcy judges use to determine undue hardship is three pronged:
1. That the debtor cannot maintain a minimal standard of living, based on current income and expenses, if forced to repay the loans;
2. That additional circumstances indicate that this state of affairs is likely to persist for a significant portion of the repayment period of the student loans.
3. That the debtor has made good faith efforts to repay the loans.
The second prong about additional circumstances is where the stipulation about a condition that prevents you from working comes from.
Private Student Loans
What about if you have private student loans? In 2005, private student loans were also deemed non-dischargable with the exception of the undue hardship standard via the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). (For more, see College Loans: Private Vs. Federal.)
The silver lining as far as bankruptcy goes is that student loan debt can be considered in your overall bankruptcy case for discharging credit card or other debt. But unless you have undue hardship, your student loans will not be discharged.
For example, if you have $150,000 worth of student loan debt on an annual salary of $30,000, you'd be a better candidate to discharge credit card or other debts. This is because your student loan debt payments would make your credit card and other debt payments harder to afford.
However, even in this case, you should still review options for reducing student loan payments before subjecting yourself to the credit rating implications of bankruptcy.
Just because you don't qualify for your student loan debt to be eliminated by the court, it doesn't mean you're out of options for payment reduction or temporary reprieves. Try one of these solutions out:
1.Try a new repayment plan
For instance, income-based repayment plans for federal student loans base monthly payments on the amount you can afford. The maximum repayment term for education loans is 25 years. However, income-based payment is usually more than your total debt and interest divided over 25 years. Why? Based on the formula used for income-based repayment, you will usually end up paying more if you can afford more than the basic consolidation payment.
If your income continues to be enough that you can afford a larger payment, you'll pay off your loan in much less than 25 years. However, a consolidation loan repayment plan offers a fixed monthly payment for the life of the loan, regardless of whether your income rises or falls. Each plan has different short-term and long-term strengths and weaknesses, so choosing between them depends on whether you need to free up cash now or in the future. (To learn about consolidation, see Should You Consolidate Your Student Loans?)
2. Get a Payment Reprieve
Take a break from your federal student loans by requesting a forbearance or deferment form your student loan servicer. These are temporary reprieves granted for reasons like short-term financial problems or active duty military service.
3. Negotiate With Lenders
Lenders of private student loans may offer you a payment reprieve or reduced payment schedule for a short time period. You may be able to get approved for an extended payment schedule that would reduce your payment significantly.
4. Look to the Future
Legislation is proposed in Congress every so often to change the standard for discharging student loans in bankruptcy to allow for inability to pay to be a factor. Despite multiple efforts, the standard remains. However, you can keep track of future legislation by searching for the terms student loans and bankruptcy on Thomas.
If you are thinking about attempting to discharge your student loans through bankruptcy, you have to be able to make the case that you will not able to work again. If this isn't an accurate description of your situation, then you'll have to explore other options. Discharging student loans through bankruptcy isn't an option for most people, but getting a break from student loan payments or switching to a repayment that's easier on the wallet is. (For further reading checkout Prevent Bankruptcy With These Tips.)