More student loan borrowers, this year, are turning to bankruptcy as a solution, according to a news release from the Department of Justice. The Justice Department recently overhauled the bankruptcy process to make it easier for eligible borrowers to have their federal student loans discharged, according to the press release.
Since that time, 632 new bankruptcy cases were filed, which the Justice Department called “a significant increase from recent years.” Fox Business reported that pre-pandemic bankruptcy cases totaled just 480 annually, on average.
Roughly 97% of all borrowers who filed used the new, streamlined process and 99% of cases have received full or partial discharges, according to the Justice Department news release.
“One year ago, we set out to simplify and improve the process for student loan borrowers in bankruptcy,” Associate Attorney General Vanita Gupta stated in the news release. “I am thrilled that our one-year review indicates that our efforts have made a real difference in borrowers’ lives by ensuring student-loan discharges are more accessible to eligible borrowers.”
Previously, student loan debt was rarely included in bankruptcy filings, as it was difficult to have it discharged. By overhauling the process, the government now evaluates several criteria to determine a borrower’s ability to pay.
The bankruptcy courts will look at the borrower’s expenses vs. income. If expenses exceed income, they are likely to see the debts discharged. The courts will also look at factors that might affect the borrower’s future ability to pay. For instance, if the person has a severe disability, is over 65, or has been unemployed for at least five of the last 10 years, the debt is likely to be discharged, according to a CNBC article.
“It makes it easier for student loan borrowers to qualify for bankruptcy discharge by clearly setting out the policy,” higher education expert Mark Kantrowitz told CNBC.
Should You File for Bankruptcy Over Student Loan Debt?
Just because it’s easier now to file for bankruptcy to have your student loans discharged, is it a smart financial choice? That depends on your other debt and your overall financial situation, according to experts.
In an article at Debt.org, Marc Merklin — partner and chair of the bankruptcy and restructuring group at law firm Brouse McDowell — pointed out: “Bankruptcy is not a goal, it’s a tool.”
He continued, writing, “You want to avoid bankruptcy if you can, but if you have multiple creditors with judgments against you, your credit’s already shot so there’s not much more damage you can do with bankruptcy.”
However, if student loan payments are your only debt — and bankruptcy could have long-term ramifications — you might seek other alternatives.
Impacts of Bankruptcy
If you’ve been making on-time payments for your other debts, including credit cards, personal loans or car loans, you likely won’t want to ruin your credit score to eliminate student loan debt.
A bankruptcy could reduce your credit score by up to 240 points, according to Debt.org. The higher your score, the more it will drop following a bankruptcy. A person with a high score of 780, for instance, could lose as much as 200 to 240 points, plunging their score into the “poor” range and making it harder, if not impossible, to secure a loan or credit in the near future.
If you plan to buy a home, finance a vehicle, or even rent an apartment in the near future, a bankruptcy on your credit report makes it much more difficult. Some employers look at your credit score before hiring, so it could even hurt your chances at that dream job — a job that could help you pay off your student loan debt.
A Chapter 13 bankruptcy filing, which involves a partial payment plan of some of your debt, can stay on your credit report for seven years. A Chapter 7 bankruptcy will affect your credit score and stay on your file for as long as 10 years.
Alternatives to Bankruptcy for Student Loan Debt
Before turning to bankruptcy as a potential solution, consider looking into deferments for economic hardship or income-driven repayment plans that could keep payments as low as $0 until your financial situation improves.
If you haven’t applied for Public Student Loan Forgiveness (PSLF), that could be a good first step. The U.S. Department of Education has also streamlined that process, making it possible to apply online entirely, GOBankingRates previously reported. The new rules also expanded who may qualify for forgiveness through PSLF, and changed what counts as a qualifying payment toward forgiveness.
Earn More Cash to Cover Your Student Loan Payments
If your student loan debt is your only debt, or you’ve been successfully making the minimum payments on other debts, consider finding ways to free up funds or earn extra cash. You might be able to find a side gig, get a second job, or sell items you don’t need.
Consolidate Other, Higher Interest Debts To Free Up Money in Your Budget
If you’re struggling with high-interest credit card debt on top of your student loan payments, you might be able to consolidate your other debt at a lower interest rate with a 0% interest credit card, personal loan, or home equity loan.
By re-evaluating your budget, you might find ways to cut back on discretionary expenses until your student loan debt is paid off.
Wait and See If New Legislation May Help Erase Your Student Loan Debt
Also, it’s worth trying to manage your student loan debt for now. No one knows what the future might bring for borrowers.
Even though President Joe Biden’s plan to forgive federal student loan debt fell through, he has introduced a new proposal that could help some borrowers find financial relief.
Biden’s “Plan B” could help borrowers who are facing severe financial hardship by eliminating their student loan debt.
