Discharging Student Loans in Bankruptcy: How the Process Actually Works

Evaluation

Finding out whether the case has a path to success before it is filed.

A student loan discharge case is decided on numbers. Before recommending a filing, we run the same analysis the government’s lawyers will run later, so there are no surprises after the case is under way.

The loan record

Every federal borrower can download a complete data file from studentaid.gov. It lists each loan, each disbursement, the school attended, the servicer, the balance, and the full repayment history. From it we work out what was actually borrowed, what is owed today, and what the standard monthly payment would be. Borrowers are often surprised by the gap between the first number and the second.

The income and expense test

Next we compare current income with necessary living expenses, using the published allowances the government itself applies. If nothing is left over to make the standard loan payment, the first and most important part of the case is in place.

A straight answer

The evaluation ends in one of three answers:

• The case is strong, and we can proceed with filing the adversary complaint, the lawsuit that asks the court to discharge the loans. See Stage 3 below.
• The case is close, and here is the documentation that would decide it.
• The case is not there today, and a different program fits better.

We would rather tell you the third answer at the start than after a lawsuit has been filed.

The Bankruptcy Case

Opening the case that makes a student loan discharge possible.

A student loan can be discharged only within a bankruptcy case. For most of our clients that is a Chapter 7 case, which also eliminates credit cards, medical bills, and other unsecured debt, usually within a few months. The process works in Chapter 13 as well.

The schedules count twice

The income and expenses listed in the bankruptcy schedules are sworn statements. The government will later compare them with the financial form submitted in the student loan case. We prepare the two together so that they are accurate and consistent from the first day.

Collection stops

Filing the bankruptcy puts the automatic stay in place. Wage garnishment, collection calls, and seizure of tax refunds for defaulted student loans stop while the case is pending.

The Lawsuit

Putting the student loans in front of the judge.

The ordinary bankruptcy discharge does not reach student loans. The court has to decide them separately, in a lawsuit filed inside the bankruptcy case called an adversary proceeding. The borrower is the plaintiff. For federal loans, the United States Department of Education is the defendant. A debtor pays no court filing fee for this complaint.

The complaint

The complaint tells the borrower’s story with figures attached: what was borrowed and when, which schools were attended and whether a degree was earned, the work history since, current income and expenses, health, and every effort made to repay. We trace each number to a document before it goes into the complaint, because the government will check.

Serving the government

Suing a federal agency has its own rules. The complaint must be served on the Department of Education, on the United States Attorney for this district, and on the Attorney General in Washington. A mistake here does not lose the case, but it can cost months.

The government responds

An Assistant United States Attorney is assigned to the case, and the court sets a status conference and a schedule. From this point the case moves on two tracks: the court’s deadlines, and the government’s review of the borrower’s finances.

The Attestation

Proving undue hardship in the form the government has agreed to accept.

The center of the process is a sworn form called the attestation. The borrower states income, expenses, assets, education, employment, health, and loan history, and supports it with tax returns, pay stubs, and other records. Government lawyers then measure it against three questions.

Can you pay now?

Income is compared with expenses. Living expenses are measured mainly by the IRS’s published standards for food, housing, transportation, and health care, with room for necessary expenses above those standards when they are documented. If what remains cannot cover the standard loan payment, this element is met.

Is that likely to continue?

The government presumes the hardship will continue when any one of these is true:

• the borrower is 65 or older;
• a disability or chronic injury limits the borrower’s ability to earn;
• the borrower has been unemployed for at least five of the last ten years;
• the borrower did not obtain the degree the loans paid for; or
• the loans have been in repayment for at least ten years.

A borrower who fits none of these can still qualify by showing the facts that make a recovery unlikely.

Have you acted in good faith?

This looks at how the borrower dealt with the loans: making payments when able, asking for a deferment or forbearance, enrolling in an income-driven plan, consolidating, or simply responding to the servicer.

Resolution

Turning the outcome into a judgment that ends the debt.

When its review is finished, the government takes one of three positions.

If the case is contested

The government’s position is not the last word. The judge applies the undue hardship standard independently and can grant a discharge the government opposed. A contested case takes longer and costs more, and whether to go forward is a decision we make with you once the government’s reasons are known.

After the judgment

The judgment is sent to the Department of Education, which removes the discharged balance. We follow up until the servicer’s records and your credit reports reflect it. Debt discharged in bankruptcy is generally not treated as taxable income.

Private Student Loans

The government’s process does not cover private loans. A private lender is sued in the same kind of adversary proceeding and the same three-part test applies, but the lender decides for itself whether to settle or fight. Many settle once the borrower’s finances are laid out.

Some private loans are not protected from discharge at all. Courts have held that a loan falls outside the student loan exception when, for example, it exceeded the cost of attendance or paid for a program at a school that was not eligible for federal aid. Those loans can be discharged like ordinary debt. We review the loan documents for this before anything else.

When Bankruptcy Is Not the Answer

Part of our job is to say so when another route is better.

• You can afford the payment. If the numbers show significant room in the budget, an income-driven repayment plan is the realistic option.
• You work in public service. Public Service Loan Forgiveness may eliminate the balance without a bankruptcy.
• You are totally and permanently disabled. The Department of Education has its own discharge for that, with no court case.
• Your school closed or misled you. Closed-school and borrower-defense discharges exist for those situations.

What It Costs

The court’s filing fee for a Chapter 7 bankruptcy is $338. There is no additional court fee for the student loan complaint when the debtor files it.

The attorney fee for the student loan case is separate from the fee for the bankruptcy, and depends mainly on whether the case is resolved by agreement or contested. Some employer-sponsored legal plans cover part or all of it. We discuss the expected cost at the first meeting, before any commitment is made.