Getting Financial Aid During And After A Bankruptcy (2020 Guide)

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In a Nutshell

Filing bankruptcy does not prevent you from getting federal student loans or other types of federal financial aid. While some federal loans do require that you have good credit (which may take a little while to build after filing bankruptcy), others don’t depend on creditworthiness. Instead, they look at your financial need based on your current financial situation. 

Written by Attorney Andrea Wimmer.  
Updated October 2, 2020


No matter where you are in your educational journey, if you’re considering filing bankruptcy, you’re probably worried about how that might affect your ability to get financial aid. When it comes to getting a student loan, a lot depends on the type of loan you’re looking for and - importantly - whether it’s a federal student loan or a private student loan. 

Anti-Discrimination Rules in the Bankruptcy Code

Bankruptcy law is federal law and appears in Title 11 of the U.S. Code (“U.S.C.”), often referred to as the Bankruptcy Code. Section 525(c) of the Bankruptcy Code states that any governmental unit that offers student aid in the form of loans or grants can’t deny aid to someone who is or has been a debtor in bankruptcy. The same rule applies to anyone in the business of offering loans that are guaranteed or insured under a student loan program from the federal government. This provision does not apply to private loans. 

Plain English Version of 11 U.S.C. § 525(c)

  • You can’t be denied federal financial aid because you’ve filed bankruptcy in the past.

  • Government student aid providers can’t hold nonpayment of a dischargeable (or discharged) debt against you. 

  • You can get federal loans while in Chapter 7 bankruptcy. 

Types Of Federal Financial Aid

Federal student aid comes in a variety of forms. Some types of federal aid don’t have to be paid back. These usually come in the form of grants, scholarships, and work-study jobs. But, since this type of financial aid usually doesn’t cover the full cost of attending a college or university, most people take out student loans to cover the difference. Student loans do have to be paid back. 

To apply for federal student aid, you’ll have to complete the Free Application for Federal Student Aid, or FAFSA form. According to the U.S. Department of Education, financial need is one of the primary eligibility requirements for most federal financial aid programs. 

Student Loan Options

Generally speaking, there are two options: federal student loans and private student loans. But, each option offers different types of student loans.

Federal Student Loans

The U.S. Department of Education offers direct loans to students. This means they act as the lender - no bank is involved. Called the William D. Ford Federal Direct Loan Program, it offers four types of direct loans, sometimes called Stafford Loans or Direct Stafford Loans.

Direct Subsidized Loans

This type of student loan has the best terms and is reserved for students with financial need. Even though interest accrues while you’re in school, the Department of Education pays the interest for you as long as you're enrolled at least part-time. So, once you graduate, your loan balance is the same as the original loan amount. There are limits to how much you can borrow. 

Direct Unsubsidized Loans

Unsubsidized loans don’t consider the borrower’s financial need. The primary difference to subsidized loans is that interest accrues even while you’re in school. So, the loan balance will be higher than the original loan amount by the time you graduate. 

Direct PLUS Loans

PLUS Loans do consider the borrower’s credit history. If a credit check reveals that you have an adverse credit history, you may still qualify for a PLUS Loan, but only if you meet certain criteria. The Department of Education considers a record of poor repayment history on one or more credit cards to be an “adverse credit history.”

Two Types Of Plus Loans

Parent Plus Loan: Parents of students in an undergraduate program can apply for this type of loan. There is a credit check, and any negative notations on their credit report will impact their ability to get this type of loan. Both parent and student must meet the other eligibility criteria for federal student aid. 

Grad Plus Loan: This is a federal plus loan for graduate students, law students, and medical students. Grad PLUS loans are loans to the student, not the parent. As with the Parent Plus Loan, the borrower can’t have an adverse credit history. If they have a bad credit score, they’ll have to meet certain additional requirements to be eligible for a Grad Plus Loan. 

Direct Consolidation Loans

A direct consolidation loan allows you to combine multiple student loans into a single loan with a fixed interest rate. This can be done at no cost and once consolidated, you may be able to access additional repayment plans and forgiveness programs.  

Old Federal Loan Programs

There are a few federal student loan programs that are no longer available. But, they still show up online when you do a search for federal loans, so it’s good to know what they are.

Federal Family Education Program

Under FFEL, the loans were made by private lenders, insured by guaranty agencies, and then insured again by the federal government. Basically, if the student defaulted on a loan issued under FFEL, the federal government would pick up the tab and repay the private lender. No new FFEL Program loans have been made since July 1, 2010.

Federal Perkins Loans

This type of federal loan has a low interest rate and was reserved to students with exceptional financial need. No new Perkins Loans have been made since September 30, 2017.

Private Student Loans

Private student loans are neither offered nor guaranteed by the federal government. They’re just like any other personal loan you receive from a bank. Loan eligibility requires good credit. So, for private loans, a bankruptcy affects a student’s ability to receive a private student loan. They often have a higher interest rate than federal loans and generally don’t offer the same kind of repayment options. Sallie Mae - previously a servicer for federal student loans - now handles only private student loans and even offers credit cards. 

How Bankruptcy Affects Student Loans 

As shown in this graph from the Federal Reserve Economic Database (FRED) student loan debt has been going up steadily since 2006. As of the second quarter of 2020, outstanding student debt added up to $1.54 trillion.[1]

Graph comparing total revolving credit and student loans over time

An interactive version can be found at this link. In part, this is because the cost of higher education has been increasing steadily. But, the perceived inability of student loan borrowers to discharge this type of debt in bankruptcy hasn’t helped. 

A bankruptcy filing can discharge federal student loans, but only if the bankruptcy judge finds that it would be an undue hardship for the borrower not to do so. Under current bankruptcy laws, this requires the person filing bankruptcy to bring an adversary proceeding

Overview Of An Adversary Proceeding To Discharge Student Loans In Bankruptcy 

It doesn’t matter what type of bankruptcy is filed. Student loan borrowers in both Chapter 7 and Chapter 13 bankruptcy can bring an adversary proceeding against to discharge student loans. But, since Chapter 13 bankruptcy requires a payment plan and involves filers with a monthly income sufficient to make monthly payments, showing undue hardship is more difficult. 

The purpose of the adversary proceeding is to show the bankruptcy court that your current income isn’t enough to maintain a minimal standard of living while having to make student loan payments. If you can make this showing, the bankruptcy discharge will give you a true fresh start by wiping out your student loan debt. 

Why do people say student loans can’t be discharged in a bankruptcy proceeding? 

Because it’s not automatic, like it is for credit cards, or other personal loans. It takes an extra step, and bankruptcy courts have often made it hard for student loan borrowers to discharge student loans. There’s the Brunner Test, for example, which requires you to show that you’ve made a good faith effort to pay back your loan. 

If you haven’t made student loan payments, that can be held against you, even if you had a deferment. You also have to show that your inability to make student loan payments will continue for a significant portion of the repayment period for the loan. 

Fore more on how to discharge student loans in bankruptcy check out this article titled Discharging student loans in bankruptcy: The Brunner Test in Upsolve’s Learning Center. Bottom line, while hard, it’s not impossible. In fact, of the bankruptcy filers that have tried, 40% have received some kind of student loan debt relief as part of their bankruptcy case.[2]

Let’s Summarize…

Filing bankruptcy does not prevent you from getting federal student loans or other types of federal financial aid. While some federal loans do require that you have good credit (which may take a little while to build after filing bankruptcy), others don’t depend on creditworthiness. Instead, they look at your financial need based on your current financial situation. 

A bankruptcy discharge can eliminate student loan debt, but until Congress passes student loan reform, the burden is on the filer to show that their financial situation prevents maintaining a minimal standard of living while in a student loan repayment program. Call your representative and your senator to demand a vote on the Student Borrower Bankruptcy Relief Act of 2019 or similar legislation. You can find their number here


Sources:

  1. Federal Reserve Bank of New York. (2020, August). Quarterly Report On Household Debt and Credit 2020:Q2. Retrieved September 26, 2020, from https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2020Q2.pdf
  2. Jason Iuliano. (2011, July). An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard. 86 American Bankruptcy Law Journal 495 (2012). Retrieved September 26, 2020, from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1894445

Written By:

Attorney Andrea Wimmer

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Andrea practiced exclusively as a bankruptcy attorney in consumer Chapter 7 and Chapter 13 cases for more than 10 years before joining Upsolve, first as a contributing writer and editor and ultimately joining the team full time in August 2019. While in private practice, Andrea ha... read more about Attorney Andrea Wimmer

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