Student loan debt is a concern for millions of young students and recent graduates. Recent estimates have stated that borrowers collectively owe an astounding $1.5 trillion of student loan debt. According to Forbes.com, it is now the second-highest consumer debt behind mortgages.
This vast amount of debt is crushing. The American Bankruptcy Institute suggests this level of debt may be preventing people from buying homes, taking vacations, possibly even delaying marriage, and starting families. This onus has led some to seek extreme options such as bankruptcy. However, bankruptcy may not be a viable option for those faced with what seems like insurmountable debt.
An individual can declare one of two types of bankruptcy - chapter seven or chapter thirteen. As Steven Abelman of Brownstein Hyatt Farber Schreck States, “Chapter seven is a liquidation…of nonexempt assets. Chapter seven gives you a fresh start in short order.” Chapter thirteen, conversely, is a personal reorganization. A budget is put into place that needs to be followed for three to five years before the debt can be discharged.
Discharging Student Loan Debt Then and Now
Prior to 1976, student loan debt could be discharged through bankruptcy like any other consumer debt. Then, the law changed stating that student loan debt could only be discharged after five years of repayment—it was soon upped to seven. Finally, in 2005, the law changed to state that no student loan debt, federal or private, could be discharged in bankruptcy unless you could prove that not doing so would create undue hardship.
These days to file bankruptcy with an attempt to discharge student loans, you must file either chapter seven or chapter thirteen bankruptcy along with a separate action called an “adversary proceeding.” This added action asks the court to find that continuing to pay your student loans would cause an undue hardship. Without this separate filing, the court will not consider discharging student loan debt.
To determine undue hardship, the court will use a test. While there is not a single test used, the most common and well-known test is the Brunner test. It consists of three standards and all must be satisfied for the court to discharge student loans.
- Poverty - It must be shown that paying your student loans would mean you could not maintain a minimal standard of living.
- Persistence - There has to be evidence that your current financial circumstances are likely to persist for a significant duration of time.
- Effort - You must prove that you have made a good-faith effort to try and pay the loans.
These standards are incredibly high and difficult to meet as Abelman states, “It’s not workable for most people.”
Ramifications of Bankruptcy
Given the difficulty in discharging student loans, people need to understand some of the ramifications of bankruptcy before pursuing it—even as the last option.
When someone files bankruptcy, an automatic stay is issued. This means that creditors and collections can no longer pursue actions like foreclosure or wage garnishment; however, this stay does NOT suspend interest accruing on your loans. Since student loans are so difficult to discharge through bankruptcy this will possibly only further add to the financial burden.
Naturally, declaring bankruptcy affects your credit score for seven years. Although as Abelman points out, “Defaulting on your loans also effects your credit score.” Nevertheless, a low credit score can make borrowing money exceedingly difficult and may subject you to higher interest rates.
Possible Student Loan Relief Changes
While bankruptcy is an option, currently it is extremely limited. This will remain the case, unless Congress changes the law. There have been some developments regarding statutory action. In February 2019, the American Bankruptcy Institute issued a 274-page report on consumer bankruptcy and proposed some amendments to bankruptcy laws regarding student loans. In May of 2019, a student loan debt relief bill was introduced and is currently awaiting committee review. However, the prospect of it passing appears to be low.
Alternatives to Bankruptcy
What are your best solutions if you are plagued with student loan debt and bankruptcy isn’t a viable possibility? The options include alternative payment plans such as income-based repayment. Under this plan, you may pay more over the course of the loan but can keep creditors at bay and your credit score intact. Some loans also have deferment options, this again will create a bigger burden but if you find yourself in a temporary financial pinch it could be a short-term solution. There are more options slowly coming available for student loan refinancing, consolidation, and possibly even forgiveness.
Even if you are in financial straits Abelman suggests, “Because of the nature of student loans, make the payments that you can.” But don’t give up hope, do your research to find the best choice for you. If your situation is extreme, you should consider contacting a bankruptcy attorney to help you determine what relief options are available and if bankruptcy is something to pursue.