Can Personal Bankruptcy Wipe Out Your Student Debt?

You have $165,000 in student loan debt and your annual income is just $40,000. With the compounded interests accumulating, you don't see how you can possibly pay down your outstanding loans. You consider bankruptcy, but you've heard the taboo about filing for BK, plus the qualifications are pretty steep to discharge student loans in chapter 7. So what’s one to do when the amount of debt exceeds income? Are there any options available outside of bankruptcy for overcoming your seemingly insurmountable debt?

What it takes to discharge government-backed student loans in bankruptcy

Unfortunately, it is almost impossible to get rid of student loans in any bankruptcy filing. In the rare instance where it can be done, one must prove "undue hardship" would be the result of paying back government-backed student loans. In non-legal terms, undue hardship means that paying your accumulated student debt will force you to live below the povery line, or that you have a severe mental or physical disability that prevents you from earning enough money to repay that debt. Undue hardship has to mean more than simply not being able to afford the monthly payments.

The stringent standard most judges reside by comes from a 1987 court case, Brunner v. New York State Higher Education Services Corp. This is the three pronged test most bankruptcy judges use to determine if repayment of your student loans would cause undue hardship:

• It must be proved that the debtor cannot maintain a minimal standard of living, based on current income and expenses, if forced to repay the loans.
• It must be proved that the financial hardship is likely to persist for a significant portion of the repayment period of the student loans.
• It must be proved that the debtor has made good faith efforts to repay the loans.

There is also a second part about additional circumstances indicative of what aggravated conditions must prevent you from working and making a decent living.

What about private student loans?

Unfortunately in 2005, private student loans were also deemed non-dischargeable unless the person filing for bankruptcy can prove an undue hardship would be the result of paying back the loan. The standard for non-repayment has to meet the Bankruptcy Abuse Prevention and Consumer Protection Act standards (BAPCPA).

However there is a ray of hope for those struggling with student loan debt. Your student loans can be taken into consideration in your overall bankruptcy case. A judge may weigh your credit card bills and other obligations against your student loans and be more willing to forgive any other outstanding debt. But unless you have undue hardship, your student loans will not be discharged.

As an example, if you have $165,000 worth of student loan debt on an annual salary of $40,000, you would probably qualify for a discharge of credit card or other debts because, if you’re also making credit card payments, then your student loan payments will be very hard to pay off.

Here are some alternatives

There are alternatives for people drowning in student loan debt. Although you may not qualify for your loans to be discharged by the court, it doesn’t mean you're completely out of options. Here are a few solutions you may want to explore:

1. Try and Arrange a New Repayment Plan: The government offers income-based repayment plans for federal student loans. You make monthly payments on the amount you can afford to pay with a maximum repayment term of 25 years. The major drawback is that over a 25 year repayment plan, you pay more than your total loan was worth once interest is factored in.
2. Request a Payment Reprieve From Your Loan Provider: You can also take a breather from paying back your student loans by asking for what’s called a forbearance or deferment from your loan servicer. This means your requesting a temporary reprieve because of short-term financial problems or active duty military service.
3. Negotiate With Lenders For Better Repayment Terms: The lenders of private student loans, such as banks or private institutions, may offer you a reduced payment schedule for a short time period. See if you can get approved for an extended payment schedule that would reduce your monthly payment obligations.
4. Look to the Future: President Obama recently approved legislation that will provide bigger grants for college students who need them and relaxed payment terms for students with outstanding loans. Students who have low incomes or meet certain other eligibility requirements and who take out loans after July 1, 2014, will see their payments limited to 10 percent of their discretionary income after graduation.

Current law caps payments at 15 percent of income. For students who make their loan payments on time, the government will forgive the balance after 20 years, instead of 25. Public service workers — teachers, nurses, police officers and those in the military — will see any remaining debt forgiven after just 10 years of repayment.

Conclusion: chances are you'll have to bite the bullet

Fully examining the student loan problem and its damaging impact is beyond the scope of this article. The best cure is to try and avoid compounding debt so your student loans don't start looking like a jumbo mortgage. But if you can't, be prepared to make a strong case as to why you are unable to repay your student loans.

An individual who wants to succeed in discharging loans through bankruptcy must prove he / she will not be able to work again or that repaying the loans will cause undue hardship. Keep in mind this is a pretty extreme solution to choose. If you are young, healthy, without dependents and crippled by debt, the odds are unfortunately against you. If relief through bankruptcy isn't an option then explore the other options available to you. An alternative payment plan that's easier on the wallet might work for you.