How to Get Your Student Loans Forgiven in Bankruptcy

“Student loans can’t be discharged in bankruptcy,” has been repeated so often that it’s practically considered gospel. But what if that “fact” is not completely correct – and may be stopping consumers who could benefit from bankruptcy from pursuing it?

It’s not just consumers and the media that may be misled. “A wide number of bankruptcy attorneys are convinced that student loans can’t be discharged under bankruptcy and never even try to include them or pursue an adversary hearing to go for the discharge,” writes Steve Rhode who has been writing about discharging debt in bankruptcy at his website GetOutOfDebt.org.

Most Don’t Even Ask

Rhode points to research by Jason Iuliano, who delved into this issue as a Ph.D. student at Princeton University. (He also holds a law degree from Harvard.) Iuliano found that nearly 40% of student borrowers who seek a discharge get one, but that many borrowers don’t bother to ask. In fact, less than 1% of those who file for bankruptcy attempt to include these loans. “The real failing of the student loan discharge process is lack of participation by those in need,” he wrote in his research paper, An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard.

Yes, it can be difficult to wipe out student loans by filing for bankruptcy, but it’s not always impossible, and some consumers who might be able to eliminate student loan debt don’t even try. That can leave a borrower saddled with debt for decades, which not only hurts their credit rating but also leaves them in a situation where their balances just continue to grow.

To get rid of student loans through bankruptcy, debtors must file something called (ominmously) an “adversary proceeding” in which they have to prove that paying back their student loans would constitute an “undue hardship” on the debtor and the debtor’s dependents. But because Congress didn’t spell out what constituted an undue hardship, that job has fallen to the courts to interpret. And not surprisingly, various judges have held various positions on the issue.

The Major Factors

Looking at a variety of factors, Iuliano found only three that he said were “statistically significant across a wide variety of models”:

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whether the debtor has a medical hardship;
whether the debtor is employed;
and the debtor’s income the year before filing bankruptcy.

Those who had a medical hardship were more likely to be successful in obtaining a total or partial discharge, and it did not appear that there was a significant difference between mental illness, physical disability or chronic illness. As far as income and employment are concerned, there “is a clear and substantial dropoff in income as one proceeds from no discharge ($28,272) to partial discharge ($20,072) and, finally, to full discharge ($16,394),” he wrote.

Is it possible that the perception that loans can’t be wiped out in bankruptcy has become a self-fulfilling prophecy? Debtors think it’s impossible, so they don’t try. As a result, the number of successful cases remains small.

In his sample, Iuliano found that 25% received full discharges (meaning all their student loan debt was wiped out) and an additional 14% received partial discharges. While that’s not a majority, it’s certainly more than many people might expect. Also surprising was the finding that borrowers who represented themselves (pro se) were a little more likely to be successful than those who were represented by attorneys.

He noted that some borrowers pursued other options such as Income Contingent Repayment, but calls them a “poor substitute” for bankruptcy because they can result in a borrower paying for years, only to potentially owe taxes on any debt that is forgiven at the end of the program.

The National Consumer Law Center has criticized the findings of this study, pointing out that it can be expensive and difficult for borrowers to try to get a discharge. Some student loan holders and their agents very aggressively fight discharges and borrowers who may need this relief may not be able to afford to file for bankruptcy, much less afford the additional costs involved in bringing a hardship discharge adversary proceeding. And, of course, there is by no means any guarantee of success.

Student loan borrowers who are trying to get out of debt should consider all their available options including loan forgiveness programs, income-based repayment and more flexible repayment plans. But they may also want to look into bankruptcy. By not doing so, they may be missing an opportunity for a truly fresh start.

“One cannot help but wonder why more people in bankruptcy do not seek to discharge their student loans,” Iuliano wrote. And Rhode is even more blunt, urging consumers to take action. “More consumers should pursue a student loan discharge in bankruptcy,” he wrote.

Before you file, make sure you’re aware of how a bankruptcy can affect your credit. A bankruptcy will remain on your credit report for up to 10 years and can drop your credit scores significantly. If you want to get an idea of where you currently stand, you can see your credit scores for free every month on Credit.com.