Can Bankruptcy Help with Student Loans?

Millions of recent college graduates and current students are facing overwhelming student loan payments at a time when the job market is extremely tight and starting salaries are barely enough to pay rent, food and basic living expenses.  There is often nothing left over to make payments on student loans which generally start six months after leaving school or graduation.

For all borrowers, the average student loan debt in 2011 was $23,300,with 10% owing more than $54,000, and 3% owing more than $100,000.

Is there any way bankruptcy can help?

In general, in terms of cancelling these debts, the answer is unfortunately no.  The Bankruptcy Code excerpts from discharge all government guaranteed loans (which are most student loans) and any debts to a non-profit educational institution such as a state college or university.  While students can often apply for and receive deferments of their payments if they are unemployed, the debts continue to accrue interest, so the balances are much higher when the debt comes out of forbearance.

Bankruptcy can help, however,  with the ability to repay student loans, by compartmentalizing a person’s overall debt problems into categories, student loan and non-student loan, and processing the bankruptcy to eliminate the non-student loan debt, thus making it easier to work out a practical repayment plan when the person filing becomes otherwise debt free.  This is a very common and effective strategy.

For example, if during school an individual borrows $10,000 in student loans, but also borrows $10,000 in credit cards to meet expenses not covered by the loans, and also takes out a $15,000 car loan for a car they may no longer need or be able to afford, they can file a chapter 7 Bankruptcy, rid themselves of the non-student loan debts and focus on establishing a repayment plan on the student loan when the bankruptcy is complete.  Another benefit of this strategy is that all creditors are “stayed” or prohibited from collecting on a debt during the pendency of the bankruptcy which can average six months or more.

This allows a person filing  bankruptcy some “breathing room” from all debt problems during the pendency of the case, and a chance to contact the student loan lender to make payments on the student loan after the case is over.  It is rare, but we have heard of some student lenders allowing a “administrative discharge” voluntarily to a person in bankruptcy if the person contacts them directly and the lender determines they no longer wish to pursue collection of the debt.

Student loans can also be either paid partially or in full through a Chapter 13 bankruptcy, but this is often not practical for a newly graduated student without regular, steady predictable income over the three to five year period of a Chapter 13 plan.

Finally, there is a remedy in bankruptcy called a hardship discharge, granted under the most extreme circumstances, when the court determines that payment of the debt will impose an undue hardship on the the person or their dependents.  This can be a costly and difficult and  is usually not available to graduates who are working or have a possible ability in the future to repay these debts by an improved economic situation which is hopefully possible when a student can finally apply their education to good use and earn a decent income.