There’s a myth going around that even if you declare bankruptcy, you still have to pay our student loans. This just isn’t true. You can have your federal student loans discharged in bankruptcy if you file an adversary proceeding, which means a court finds repayment of your student loans to cause undue hardship to you and your dependents. But how does bankruptcy work and is it a smart decision?
How Does Bankruptcy Work?
Bankruptcy is a court proceeding whereby a judge and a court trustee determine if your debts should be discharged because you can’t afford to pay them any longer. They’ll examine your assets and liabilities in order to reduce, restructure or eliminate your debt. Bankruptcy can carry long-term penalties because it stays on your credit report for 7 to 10 years.
The biggest benefit of bankruptcy? A clean slate. Although it can take six months or more to complete, you will feel the burden lift off your shoulders because you are officially debt-free.
One caveat, though, is that bankruptcy eliminates some of your debt, but it won’t eliminate all of it. Credit card debt can be eliminated through Chapter 7 and Chapter 13. Sometimes Chapter 13 can help with child support, tax debt, student loan, and secured debts.
How Does Chapter 7 Bankruptcy Work?
If you file for Chapter 7 bankruptcy, you need to know what will happen to any property that you own. Chapter 7 can wipe out all of your debt, but some debts won’t be erased. Chapter 7, which is also known as liquidation bankruptcy, enables you to keep “exempt” property. This all depends on the state you live in and can be anything from your entire home to only $5,000 in equity in your home.
Filing Chapter 7 includes steps such as going to credit counseling, hiring an attorney, taking the means test, completing paperwork, and more. It’s a lengthy and complicated process that requires patience and diligence.
How Does Chapter 13 Bankruptcy Work?
In Chapter 13, you can keep your property and repay debts through a repayment plan for up to five years. The amount that you pay depends on whether you have secured or unsecured debts. You usually pay only some of your unsecured debts via the plan and the rest is discharged. The law will give higher priority to certain debts meaning you have to pay those off first.
A Chapter 13 can stop a mortgage foreclosure. This means that the lender will have to accept a plan in order for you to make up for payments that you missed. It will also allow you to keep the property. Also, you are able to “cram down” secured debts in which you owe more than what the property is worth. For example, if you owe $15,000 on a car that worth only $5,000, you can “cram down” the amount owed to $5,000 and have the $10,000 discharged. This doesn’t apply if you bought the car within 30 months before you filed for bankruptcy.
- Financial experts focused on Student Loan Debt Forgiveness
- Qualify for programs to get $5,000 off – total debt forgiveness.
- US government programs designed to help reduce debt.
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What Can Bankruptcy Do?
Bankruptcy can be a powerful tool for some people drowning in debt, because it can:
- Eliminate credit card debt. A credit card balance is an unsecured debt, which means the lender doesn’t have collateral and cannot repossess any assets if you don’t pay it. Filing Chapter 13 means you might have to pay back some of your unsecured debts through a payment plan.
- Stop creditors from harassing you. If a creditor is going to repossess your car or foreclose on your house, then bankruptcy can help you. If you need to stop phone calls and letters, you can do that in other ways.
- Get rid of certain kinds of liens. A lien is a legal right that acts as a guarantee for repayment of a loan. If the obligation to pay is not met, then the creditor can take the asset that the lien stands for.
What Can’t Bankruptcy Do?
Bankruptcy isn’t a cure-all, because it cannot:
- Prevent repossession of property for failure to pay secured debt. Bankruptcy doesn’t eliminate liens, so a creditor can repossess your asset that stood in for the lien.
- Eliminate your obligation to pay child support. In addition to alimony, child support survives bankruptcy.
- Eliminate most tax debts. It’s very hard to erase tax debts through bankruptcy. It can sometimes be possible if the debts are for unpaid income taxes from long ago.
- Erase all debts including debts owed related to personal injury or death caused by drunk driving and fines for violating the law.
How Does Bankruptcy Work With Student Loans?
The law states that the court must find that a student loan would cause undue hardship in order for it to be discharged through bankruptcy. This can be a difficult process. A judge determines if your situation qualifies as undue hardship and often use the Brunner Test, which is a way to look at the totality of your circumstances.
What is the Brunner Test?
The Brunner test shows that under undue hardship, the person in debt shows that he cannot maintain a “minimal” standard of living for himself and his dependents if he continues repayment and that additional situations exist showing that this state of affairs will continue for a long period during the repayment of the loan. You must also show that you tried to pay the loans back.
When Not to Pursue Bankruptcy For Your Student Loans
If you have student loans and are thinking about bankruptcy, here are a few instances when bankruptcy isn’t a smart move:
- If you have other ways of discharging your loans such as with forgiveness programs. Public Service Loan Forgiveness, for example, will discharge your unpaid balance after 120 timely monthly payments. This is tax-free and not nearly as complicated as bankruptcy.
- If you can’t prove undue hardship. Under the law, you need to be able to prove that repaying your loans would cause undue hardship to yourself and your dependents.
- If your income is low, consider an income-driven repayment plan. Payment in an IDR can be as low as $0.00 per month and can last the entire life of the loan if your income stays the same. Also, after 20-25 years of ayment in an IDR, the loans are completely forgiven.
Think Carefully Before Seeking Student Loan Bankruptcy
There’s a lot of misinformation about bankruptcy and how bankruptcy works, which can make it confusing if you’re seeking answers related to your situation. Carefully assess what route is right for you, whether it be by consulting a lawyer, financial adviser or researching other options available to you. If you feel like paying back your student loans is too much and you need help, then find a resource you trust and you’ll soon be able to get back on track.
Compare the Best Student Loan Refinance Rates
Here are our top student loan refinance picks for 2019
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Student Debt Relief Loan Refinancing Advertiser Disclosure
College Ave: College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply.
College Ave Refi Education loans are not currently available to residents of Maine.
1 – The 0.25% auto-pay interest rate reduction applies as long as the borrower or cosigner, if applicable, enrolls in auto-pay and authorizes our loan servicer to automatically deduct your monthly payments from a valid bank account via Automated Clearing House (“ACH”). The rate reduction applies for as long as the monthly payment amount is successfully deducted from the designated bank account and is suspended during periods of forbearance and certain deferments. Variable rates may increase after consummation.
2 – $5,000 is the minimum requirement to refinance. The maximum loan amount is $300,000 for those with medical, dental, pharmacy or veterinary doctorate degrees, and $150,000 for all other undergraduate or graduate degrees. Information advertised valid as of 04/26/2019. Variable interest rates may increase after consummation.
3 – This informational repayment example uses typical loan terms for a refi borrower with a Full Principal & Interest Repayment and a 10-year repayment term, has a $40,000 loan and a 5.5% Annual Percentage Rate (“APR”): 120 monthly payments of $434.11 while in the repayment period, for a total amount of payments of $52,092.61. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary.
ELFI: Subject to credit approval. Terms and conditions apply. To qualify for refinancing or student loans consolidation through ELFI, you must have at least $15,000 in student loan debt and must have earned a bachelor’s degree or higher from an approved post-secondary institution.
LendKey: Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
CommonBond: Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate.
Splash Financial: Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval.com
Earnest: To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest’s fixed-rate loan rates range from 3.89% APR (with autopay) to 7.89% APR (with autopay). Variable rate loan rates range from 2.50% APR (with autopay) to 7.27% APR (with autopay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms of 10 years or less. For loan terms of 10 to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 0.26% and 5.03% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of April 23, 2019 and are subject to change based on market conditions and borrower eligibility.
Auto Pay Discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 04/23/19. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice.
Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 303 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, e-mail us at email@example.com, or call 888-601-2801 for more information on our student loan refinance product.