Federal and Private Student Loan Bankruptcy and Discharge Guide

Student loans are those debts that are taken out for the expressed purpose of funding one’s college education, and they may be either federal or private in nature. Most students need some type of outside funding for higher education, and it is very important that they understand the obligations of the loans that they are obtaining.

Federal student loans are loans that are provided by the federal government to students and their parents to pay for school. Eligibility for such loans is determined by the filing of the Free Application for Federal Student Aid (FAFSA). Private student loans, on the other hand, are provided to students or their parents by some source other than the federal government.

Whether federal or private, student loans are unique in comparison to other loans – particularly in the repayment obligations bestowed on their borrowers. As has always been the case with federal student loans, and has expanded to private student loans with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, such debt is considered “non-dischargeable”.

Non-dischargeable debts, which also include taxes, spousal support, and child support, are those debts that cannot be eliminated through filing bankruptcy except in very rare cases. When you take out a student loan, your repayment is considered obligatory. This can come as quite a surprised to the uninformed former student who finds him- or herself in a difficult financial situation.

Bankruptcy

Bankruptcy is a financial last resort, and no one should consider filing until they have considered all of their other debt relief options such as debt settlement and credit counseling. After searching for another way out of debt, however, may people decide that bankruptcy is their only choice.

Most debtors file either Chapter 7 or Chapter 13 bankruptcy, and the manner in which student loans are implicated differs between the two.

Student Loans and Chapter 7

Chapter 7 is liquidation bankruptcy, or the type of bankruptcy that results in a discharge of one’s debts. Student loans cannot be included in a Chapter 7 bankruptcy, unless the filer can prove that making student loan payments would cause “undue hardship” on him or his family.

To be considered for the hardship exemption for repayment, you must file a separate motion with the bankruptcy court. You must then explain your hardship to the judge. In general, hardship may be granted only if:

1. You can prove that making your student loan payments would cause you to fall below a minimum standard of living.
2. You can show that your financial difficulties will be long-term with little hope of improvement.
3. You have made an effort in the past to repay your student loans.
   

In actuality, this exemption hardly ever is granted unless you have a physical condition that does not enable you to work, and if there is no chance that you will be able to find sufficient employment in the future.

Student Loans and Chapter 13

Chapter 13 is reorganization bankruptcy, or the type of bankruptcy that results in a reorganization of one’s debts and a repayment plan (usually 3 to 5 years in length) under the discretion of the bankruptcy court. Generally, any debts that remain unpaid after the reorganization are discharged.

Both federal and private student loans can be included in the reorganization. You might be able to make a slight difference in your debt, but this will depend on a wide variety of factors. In the end, you still will owe most, if not all, of your student loans.

While bankruptcy most likely will not help to relieve you of your liability for student debt, it still can be a helpful move for the borrower whose debt is made up mostly of other types of debt. The ability to discharge part or all of other debts will free up more money for you to be able to pay off your student loans.

Consequently, if your student loans are the main part of your debt load, then it almost certainly is not worth it for you to file bankruptcy. Yet, you have to take some type of action. Since the passing of the Higher Education Technical Amendments of 1991, you no longer even have the protection of a statute of limitations on your student loan debt.


Other Options

If you are having difficulty making your student loan payments, then you should speak honestly with your lender(s). Many will be happy to work with you to come up with a repayment plan that will fit into your budget. If your present situation is so that you cannot realistically pay anything, then ask your lender to defer your obligation to pay until your finances improve.

If you have not already done so, you might want to consolidate your student loans. Consolidation combines various loans into one, so your bill-paying process is simplified and you may be able to obtain a lower interest rate. Both private student loans and federal student loans can be consolidated – though they cannot be consolidated together.

Should you fail to discharge your debts and have not made arrangements with your lender, then you may be subject to collections procedures or lawsuits.

Is there any way to get rid of student loan debt?

There are certain circumstances outside of the hardship exemption in bankruptcy that might result in a forgiveness of student debt. However, they are not very useful for the average student. Student loan debts absolutely cannot be forgiven just because you did not like school, did not finish school, or could not find job afterward.

Instead, your debt might be forgiven in-part or if you work in a designated job like teaching in a specific low-income area. If there is a major issue with one’s school, like if it closes while he or she still is attending, or if a student loan borrower dies, then the debt also is forgiven entirely. Like I said, not particularly helpful for most people!

Conclusion

When you take out a student loan, whether federal or private in nature, you have an obligation to repay. While it is possible for your debt to be altered slightly through Chapter 13 bankruptcy filing, or discharged through extremely rare cases of Chapter 7 filing, you should not rely on bankruptcy if you are unable to make your loan payments. Instead, work with your lender to come up with a solution with which you both can work.