Student Loan Bankruptcy Options

Student loans and bankruptcy filings used to be connected by a relatively simple process. Of course, nothing is simple when it comes to bankruptcy. The recent rise of bankruptcy filings has led to some very significant impacts on student loan forgiveness.

Student Loan Discharge

As a backdrop, student loans are considered unsecured loans, meaning there is no collateral, such as a car, which can be repossessed as payment toward the loan. You cannot unlearn what you were taught, and no one is taking your college diploma from you. But with the rising rate of bankruptcies here in the United States, it was too "easy" to simply declare bankruptcy and have your student loans discharged.

Bankruptcy Law Changes

Additional Resources

In 1998, there was a significant change to the bankruptcy law under Chapter 7 and Chapter 13, which made it difficult to have your student loan discharged. The change meant that even if you declare bankruptcy, you may still have to pay back all outstanding student loans. Recognizing that this policy could create tremendous financial burdens on some individuals or families, a three part test was established to determine hardship.

Bankruptcy Hardship Rules for Student Loans

In the normal course of bankruptcy, student loans will not be discharged or forgiven. However, after the initial bankruptcy proceedings are over, an adversary proceeding can take place in bankruptcy court to decide if you meet all three of the hardship rules or tests.

In this adversary proceeding, the student loan creditors will be present to challenge your hardship request. You must be able to satisfy all three of the following tests in the eyes of the court:

If you were forced to repay the student loan, then you will not be able to maintain a minimal standard of living.
You are able to present evidence that this financial hardship will continue for a significant period of time over the remaining term of the student loan.
A good faith effort was made to repay your student loan before you filed for bankruptcy. Effectively, this means you have been faithfully repaying your college loan for a minimum of five years.

If your loan is discharged, then you will not have to repay the remainder of the money owed these creditors. However, you may have trouble getting a student loan of any kind in the future.

Student Loan Payment Relief

In addition to bankruptcy, there are actually five additional options you have when seeking payment relief from your student loans. These options include:

Deferring Payment on a Student Loan
Student Loan Forbearance
Student Loan Forgiveness
Flexible Loan Repayment Options
Student Loan Consolidation

In the following paragraphs, we're going to discuss each of these options, which allow you to pay back your student loan without going through bankruptcy. They also become viable options when you do not meet the student loan hardship rules mentioned earlier.

Deferring a Student Loan

The first option you have is called deferment. We've talked about this at length in our article on Student Loan Deferment, but deferment is suspending, or deferring, the student loan payments for specified periods of time, and under specific conditions. For example, you may be eligible for student loan deferment due to unemployment, disability, or military service.

Student Loan Forbearance

Instead of declaring bankruptcy, you also have an option known as forbearance. Student loan forbearance is the temporary postponement of payments, or a reduction in payments, for a specific period of time. This arrangement is worked out with the lender, or creditor, and is in-effect until the financial difficulty is over.

Student Loan Forgiveness

Perhaps the most desirable of all alternatives to bankruptcy would be to have your student loan forgiven or discharged. A loan forgiveness program will repay a percentage of a former student's educational debt in exchange for work in a designated job. Unlike service payback programs, which pay for educational expenses while the student attends college, forgiveness programs pay off a student's loan after they start working.

We have an entire article dedicated to the topic of student loan forgiveness; including the types of programs that exist, as well as how to qualify.

Student Loan Repayment Options

The fourth option you have involves taking advantage of one of several loan repayment programs. These options include graduated payment options and even income sensitive payment options. These arrangements are covered more thoroughly in our article: Student Loan Repayment. These plans allow you to increase your monthly payments over time, or have them automatically adjusted as your family income increases or decreases.

Student Loan Consolidation

Finally you may be able to find relief from your high monthly student loan payments by consolidating your student loans. As soon as a student graduates, or drops below half time enrollment status, they are eligible to consolidate any Direct Loans or FFEL Loans that are outstanding.

If you've been delinquent in paying back your federal student loans, then you may not be immediately eligible for loan consolidation. If that is the case, then you need to contact the holder of the loan to find out what corrective actions you can take before becoming eligible once again. You can find more details about this alternative in our article: Student Loan Consolidation.

Federal Student Aid Ombudsman

If you are thinking about declaring bankruptcy, and your student loans are a big factor in your decision, the Department of Education has established an ombudsman to help. This office has checklists and tools that can help you figure out the best approach to deal with your financial crisis. Think of the Federal Student Aid Ombudsman as a consumer advocate for student loans. For more information about this service, just visit the FSA Ombudsman website.

Finally, if you are looking for broader alternatives to bankruptcy, then you should take a look at our article on Debt Elimination. That article discusses approaches such as budgeting, debt counseling, in addition to debt consolidation.

About the Author - Student Loan Bankruptcy Options

Leasing / Buying a Car