Bankruptcy and Student Loans

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 What Happens If I Cannot Make Payments on My Student Loans?

If an individual is not able to make payments on their student loans, there may be some options available to them. An individual should be very careful to avoid defaulting on a student loan, as this will significantly damage their credit as well as increase the amount of money that they owe.

If an individual is having trouble making payments on their student loans, the potential options may include:

  • Loan cancellation;
  • Postponing payments through forbearance or deferment; or
  • Filing bankruptcy and discharging the loans.

A loan forbearance is the postponement of payments in which the loan holder, such as the bank or agency that granted the original loan, allows the individual to stop making payments for a specific amount of time. A forbearance only applies to the principal sum that is owed.

Because of this, interest will continue to accrue. A forbearance is easier to obtain than a deferment but is less attractive because the individual’s total balance will increase during the forbearance because of the accruing interest.

A deferment refers to a postponement of loan payments which is based on a certain condition being met and for a certain period of time. An example of this would be how an individual may be able to obtain a deferment for being unemployed or for going back to school.

The amount of extra time that the deferment will give the individual will vary depending on the loan. In addition, in some cases, a deferment will postpone the payments of both the principal due as well as the interest.

It is important to note, however, that it is not possible for an individual to receive a deferment if they have defaulted on their student loans.

Can Student Debts Be Canceled or Discharged?

A student loan debt may be permanently canceled or discharged at the discretion of the lending institution. There are several laws which make student debt forgiveness very hard to receive

Student loan debts may permanently be canceled or discharged at the discretion of the lending in terms of discharging student loans through bankruptcy.

For example, student loan debt is not automatically discharged under Chapter 7 and Chapter 13 bankruptcy categories if a debtor files for bankruptcy. The only way to obtain a student loan discharge under bankruptcy is for an individual to prove they have a severe financial hardship.

If a lending institution does not act upon a debt promptly, that debt may, in some cases, be subject to an automatic discharge. In addition, a creditor cannot collect on a debt while a bankruptcy proceeding is pending or underway.

How Do I Cancel Student Loans?

An individual may be able to cancel all or part of their student loans by:

  • Teaching disabled students and low-income populations;
  • Joining the military or other uniformed service;
  • Performing community service;
  • Proving that the university they attended closed down;
  • The university was falsely certified; or
  • As a refund for a school that they applied for but never attended.

A cancelation of a student loan means that the loan is wiped clean and any expected payments in the future will be canceled. In addition, any prior payments that were made will be reimbursed.

It is important for an individual to keep in mind that student loans are essentially a contract. This means that if a school is not able to fulfill its obligations, it should not and would not be paid for services that were not rendered.

How can Student Loans be Discharged Through Bankruptcy?

It is very difficult for an individual to discharge a student loan in bankruptcy. Because of this, the only approach typically available to an individual is to convince the bankruptcy court that being required to repay the student loan would create a severe hardship.

Severe hardship in bankruptcy consists of the following core elements:

  • Paying off the loans would result in a failure for the individual to maintain a minimal and acceptable standard of living;
  • Circumstances dictate that this low standard of living would persist for the foreseeable future; and
  • The individual has made a good faith effort to repay the loans.

Although these elements seem relatively easy to meet, the actual legal meanings of these ambiguous phrases often prevent most debtors from pursuing a discharge of their student loans through bankruptcy. A minimal standard of living means below the poverty line in the state in which an individual resides.

Because of this, the standards for this element will vary by state. The circumstances that force an individual to live this way for the foreseeable future must also be outside the normal hardships that most individuals experience.

One example of this issue would be how unemployment is not a circumstance that meets this requirement. However, if an individual has an inhibiting medical condition, it would be one of the few examples that could be deemed an acceptable circumstance.

Lastly, the individual must be perceived as a responsible individual who has encountered some bad luck and is being crushed by their mounting debt. This element is intended to prevent individuals from abusing the bankruptcy system in order to avoid paying money that they legally owe to creditors.

Bankruptcy is a legal process that allows individuals to either reorganize or discharge their outstanding debts. With a reorganizational, or Chapter 13 bankruptcy, an individual is provided a period of time in which they can follow a payment plan to repay their creditors.

A liquidation, or Chapter 7 bankruptcy, erases many of the individual’s debts, for example, credit card debt. There are many legal and financial consequences of filing for bankruptcy.

For example, it can be very hard, or even impossible, for an individual to get a loan after filing bankruptcy. Typically, student loans cannot be discharged during bankruptcy.

Can Student Loans Survive Bankruptcy?

Under the United States Bankruptcy Code, student loans are classified as non-dischargeable debt. This means that student loans will survive bankruptcy even when all of an individual’s other debts are wiped clear.

There are a few exceptions to this rule. However, bankruptcy is not a favorable solution to student loan debt.

Are There Other Ways to Discharge Student Loans?

Yes, there may be some other ways an individual can discharge student loans. One way, as noted above, may be to show that it would place an unreasonable burden, or undue hardship, on the individual to pay back the loans.

This is a legal claim that is rarely approved. Currently, there is a split among courts as to the best way to determine undue hardship.

This split means that the court will use one of the two following tests:

  • The Brunner Test: Under this test, the debtor must show:
    • the debtor cannot maintain a minimal standard of living for themselves and their dependents;
    • the debtor cannot repay their loans in their current financial situation and for the foreseeable future; and
    • the debtor made a good faith effort to repay their loans; and
  • The Totality of the Circumstances Test: This test examines all of the important factors in a debtor’s bankruptcy case to determine if there is an undue hardship or not.

There are some student loan forgiveness programs through state and federal governments that allow individuals to discharge their student loans. An individual may be able to reduce or eliminate their student loan debt by:

  • Working for a nonprofit;
  • Serving in the military; or
  • Enrolling in other types of forgiveness programs.

If a loan is not discharged and the borrower is unable to pay, their loan will enter into default status.

Do I Need a Lawyer?

Bankruptcy law is extremely complex, especially related to student loans. If you are facing financial issues and are considering bankruptcy because you are unable to pay your student loans, it is in your best interests to consult with a bankruptcy lawyer.

Your lawyer can examine your financial situation and determine if bankruptcy is the best choice for you. In addition, your lawyer may be able to provide alternatives to alleviate your debt.

If you do file for bankruptcy, your lawyer will represent you during settlement negotiations as well as in court.

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