How will bankruptcy impact my student financial aid?

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In a Nutshell

Whether you’re still at the beginning of your career and looking to improve your knowledge in your field by going to school or heading back to school to change your career altogether, chances are you’re worried about whether filing for bankruptcy protection will limit your options when it comes to getting student loans. This article will explore the impact of filing bankruptcy on someone’s ability to get a new student loan and provide some additional context about a filer’s ability to discharge student loans in bankruptcy.

Written by Attorney John Coble.  
Updated July 22, 2020


Whether you’re still at the beginning of your career and looking to improve your knowledge in your field by going to school or heading back to school to change your career altogether, chances are you’re worried about whether filing for bankruptcy protection will limit your options when it comes to getting student loans. This article will explore the impact of filing bankruptcy on someone’s ability to get a new student loan and provide some additional context about a filer’s ability to discharge student loans in bankruptcy.

Federal Student Loans

As a general rule, federal student loan eligibility is based on need, not creditworthiness. This policy allows anyone with a high school education to pursue a college degree. There are some federal student loans that do require good credit. Private student loans always consider the creditworthiness of the applicant. All federal loans require that you’re not currently in default on your student loan debt.

A parent's bankruptcy can only impact eligibility for one type of federal student loan: A Parent PLUS loan. These are loans that the parent of a dependent student takes out to cover any costs not already covered by the student's financial aid package. For these Parent PLUS loans, a Chapter 7 bankruptcy discharge by your parents within the past five years will disqualify them from these loans. But, a Chapter 13 bankruptcy doesn't affect your Parent PLUS loan eligibility.

Today, most student loans are Direct Loans. In the past, these loans were known as Stafford loans. These are either subsidized by the Department of Education or aren’t subsidized. With subsidized loans, the Department of Education pays the interest for you while you're in school. If your loan is unsubsidized, you are responsible for the interest while in school. Most students use a deferment for this interest allowing the interest to accumulate and be added to the principal when they begin making student loan payments. Subsidized loans are based on the financial need of the student. Unsubsidized loans don’t require that the borrower show financial need. Perkins loans were student loans for students with extreme financial need. This type of loan was discontinued in 2018.

Graduate PLUS loans are for graduate students, law students, and medical students. Grad PLUS loans are loans to the student, not the parent. Unfortunately, as with Parent PLUS loans, the borrower can’t have a Chapter 7 discharge within the past five years. If you filed a Chapter 13 bankruptcy, your eligibility for a Grad PLUS loan isn’t affected. These PLUS loans are government-guaranteed loans that aren’t Stafford loans. In the case of a Parent PLUS loan or a Grad PLUS loan, if the borrower isn't eligible due to having a Chapter 7 discharge within the last five years, the borrower can still qualify for these loans by getting a creditworthy cosigner.

§525(c) of the Bankruptcy Code forbids the denial of a government-guaranteed student loan due to the bankruptcy of the borrower or the bankruptcy of someone associated with the borrower. This applies to Stafford loans and in the past, it also applied to Perkins loans. PLUS loans are government-guaranteed student loans, but Title 20 of the U.S. Code contains an exception to the Bankruptcy Code's nondiscrimination rules. This exception only applies to Chapter 7 bankruptcies. One can still have a Chapter 13 bankruptcy within the last five years and qualify for a Parent PLUS or Grad PLUS loan.

Private Student Loans

A private student loan is any student loan that's not guaranteed by the federal government. Since these loans aren’t guaranteed by the federal government, the interest rates are often higher. These loans are offered by private institutions just like any other bank loan. Large banks such as Wells Fargo and SunTrust are leading lenders for private student loans. Other types of financial institutions also make private student loans. Discover, which is best known for its credit cards, is one of the nation's largest private student loan companies. Sallie Mae, which was originally a loan servicer company similar to Fannie Mae, is now a private student loan company. Sallie Mae no longer services government loans.

Whether a parent's bankruptcy will affect a student's ability to get a private student loan is dependent on many factors. The most important factor is whether the student is a dependent of the parent. If a dependent and the parent can’t be approved, the parent will need a cosigner. If a dependent, a parent's bankruptcy within the last seven to ten years may affect the student's ability to get a private loan. A student who isn’t a parent’s dependent will have their own credit history. For an independent student with a good credit history, the parent's bankruptcy won't matter. 

Unlike most federal loans, private lenders do care about your creditworthiness. Just as with a mortgage or car loan, you're approved or denied based on your credit history. Any adverse credit history, such as bankruptcies or a history of defaulting on loans will impact your ability to get a private student loan. If you can't qualify for a private loan, you can try to find a creditworthy cosigner that may be able to help you get approved for the loan.

Does It Matter Whether I Filed a Chapter 7 or Chapter 13 Bankruptcy?

If you have filed bankruptcy, it will not impact your ability to get a federal student loan unless you are trying to get a PLUS Loan. With a PLUS loan,  Chapter 13 bankruptcy or a Chapter 7 bankruptcy more than five years ago will not affect your chances of approval. If you're trying to get a private loan, the rules are different. Different private lenders give different weights to bankruptcy on your credit report. Private lenders will consider your credit score, debt to income ratio, and the type of bankruptcy you filed. If you don't qualify, you may still be able to get the loan if you can find a creditworthy cosigner. 

Some private lenders consider a Chapter 13 more favorably than a Chapter 7 bankruptcy. This is because you have made an effort to repay at least part of your debts with a Chapter 13. This more favorable treatment of Chapter 13 filers is common. The three major credit bureaus leave a Chapter 7 bankruptcy on your credit report for ten years. These credit bureaus leave Chapter 13 on the credit report for only seven years. Private lenders will often take into consideration that you will not be able to file a new bankruptcy for a period of years after a prior bankruptcy is discharged. This is common with most bank loans. With student loans, the period since you last filed bankruptcy is less important since you have little chance, under current law, of discharging a student loan through bankruptcy. Often, student loan lenders are happy for you to file bankruptcy. By eliminating your other creditors, you have more money to keep making payments to them.

Student Loans and Bankruptcy

Even though this article is primarily geared for folks interested in going back to school with the help of student loans after getting debt relief through a bankruptcy filing, let’s take a quick look at how student loans are treated in bankruptcy.

Whether your student loan debt is private or federal, you will have a very difficult time discharging the student loan in bankruptcy. Federal loans are often harder to discharge because they offer income-based repayment plans. This relief for federal loans means that the filer will almost always fail the first element of the Brunner Test. The Brunner Test has been adopted across the country to determine if a student loan borrower is suffering from undue hardship. If undue hardship is proven, the student loan is dischargeable in bankruptcy. These three elements of the Brunner Test must all be met to prove that paying a student loan will cause undue hardship for the borrower:

  1. The filer can't maintain, based on current income and expenses, a minimal standard of living for the filer or their dependents if they’re forced to repay the student loan, and

  2. There are circumstances that indicate this state of affairs is likely to persist for a significant portion of the repayment period of the student loan, and

  3. The filer has made a good faith effort to repay the student loan.

The most common way to pass the Brunner Test is to have a permanent disability. There is some hope as some judges are trying to take an easier approach to showing undue hardship. Recently, a New York bankruptcy court erased over $200,000.00 of student loan debt for a filer who had only shown an inability to pay. Unfortunately, that case is currently working its way through the appeals process and may be reversed by a higher court.

Since 2006, outstanding student debt in our country has jumped from $480 billion to $1.64 trillion. See the graphic below:

Graph showing trend in student loan borrowing since 2006
Student loan trend since 2006

The graph above is from the Federal Reserve Economic Database (FRED). An interactive version can be found at this link.

Why have student loans more than tripled in the last fourteen years? Because people can't afford to pay these loans back! Even worse, people can't get relief from these loans in bankruptcy. Call your congressperson and your senator to demand a change. You can find their number here

In Chapter 7 bankruptcies, you can only get student loan relief if you can pass the Brunner Test. This is very difficult. In a Chapter 13 bankruptcy, student loans can sometimes be paid through the Chapter 13 plan. Often, due to the size of the student loan and the time left on the student loan, it's better to make these payments outside of the Chapter 13 plan, though that is not always an option.

Conclusion

Having a bankruptcy on your credit report can harm your ability to obtain federal PLUS Loans and private student loans. If you need one of these types of loans, it would be better to file a Chapter 13 bankruptcy. Stafford loans and other financial aid, such as grants, aren’t affected by your having filed bankruptcy. As of the writing of this article, it's unlikely that you will be able to discharge your student loans in bankruptcy. If you have student loan debt and you are considering filing bankruptcy, you should consult with a bankruptcy attorney. Please contact the school's financial aid office for additional information about your student loan needs.



About the author
Attorney John Coble

John Coble has practiced as both a CPA and an Attorney. John's legal specialties were tax law and bankruptcy law. Before starting his own firm, John worked for law offices, accounting firms, and one of America's largest banks. John handled almost 1,500 bankruptcy cases in the eig... read more

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