Are Student Loans Discharged When You File for Bankruptcy?

The option to file for bankruptcy is a legal protection that allows you to settle your debts. Settling your debts does not mean they are all discharged, and it does not mean they simply go away. The bankruptcy process categorically moves through each lien and debt until they have been settled according to their seniority. Your student loans will be a part of this process. Depending on the type of loan you have, the process will treat the loan differently.

Undue Hardship Provision

There is one provision that will allow for the discharge of your student loans. It is an "undue hardship" rule that permits you to excuse yourself from paying the debt if very specific criteria apply to your situation. You will have to prove all of the following are true in order to apply for undue hardship discharge:

  1. You cannot maintain a minimal standard of living if you are forced to repay the loan based on your current income

  2. There are circumstances showing your poor financial state will persist for the remaining repayment time on your loan

  3. You made an effort to repay the loans on time

These provisions are harder to prove on some loans than others.

Defaulting on Private Loans

When a private loan moves into default, you will see a substantial punishment on your credit score. Legal action and collections efforts will commence immediately, and you may lose the collateral you placed on the loan, if any. Once you declare bankruptcy, these processes will be forced to stop as the bankruptcy process starts. However, the loans do not simply get discharged. You will be forced to liquidate your assets in the movement to pay the loans off. Senior loans are paid first, followed by any subordinate loans.

Defaulting on Federal Loans

If you file for bankruptcy while you have open federal student loans, you will face consequences different from traditional private loans. First, you will not be able to secure another federal student loan in the future. You will see the same credit issues as you will face with a private loan. You may also be subject to a garnishment of your wages. Since the government has access to your wages through your income tax filing, this can be done at the corporate level. This means you will have no choice in the matter, and your monthly paycheck will simply be lower than it was in the past.

Preventing Default

It is not easy to get a student loan discharge. Even under the undue hardship exception, there is a lot of paperwork and scrutiny before you are provided any protection. Most people who default on loans do so because they have not taken the appropriate actions to prevent default. Federal student loans may be consolidated and refinanced at a lower interest rate through federal programs. Private loans are eligible for the same treatment from private programs. Most student lenders will also offer you the opportunity to defer payments or change your payment structure if you are experiencing a financial hardship. Speaking to your lender about these options early in the process is essential.


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