You racked up loads of student debt and now you can’t keep up. Is bankruptcy the answer?

Image source: Getty Images

Many students rack up loads of debt in the course of getting an education. In fact, Americans of all ages collectively owe more than $1.5 trillion in outstanding student loans today.

If you're struggling to keep up with your student loan payments, you may be wondering if filing for bankruptcy is a good solution. In most cases, your student debt won't be dischargeable in bankruptcy, but you may qualify for an exception. On the other hand, you'll have to weigh that benefit against the downside of having a bankruptcy on your credit history.

Can student loans be wiped out if you file for bankruptcy?

Before we talk about whether student debt can be wiped out by bankruptcy, know this: Bankruptcy doesn't always serve the purpose of eliminating debt completely. If you file for Chapter 7, which is a personal liquidation, your debts will largely be discharged. But if you file for Chapter 13, which is a personal reorganization, you don't actually get rid of your debt, but rather, come up with an effective, court-approved way of paying it off.

If you file for Chapter 13, your student loans may be eligible for a restructuring -- meaning, you'll work with your lender to come up with a system for paying back that debt. If you file for Chapter 7, you may be eligible to have your student loans discharged, but doing so is very difficult.

Why so? First of all, it's harder to qualify for Chapter 7 than it is to qualify for Chapter 13 in the first place. To be eligible for Chapter 7, you'll need to pass the means test, which measures your income relative to the median income in your state for a household of your size. Many bankruptcy filers fail the means test and therefore must resort to Chapter 13 to proceed with a bankruptcy filing.

But even if you qualify for Chapter 7, you'll still have to prove that you truly don't have the ability to pay back your student loans. Most bankruptcy courts use what's known as The Brunner Test to measure the hardship involved in repaying student debt. Under this test, you may qualify to have your debt eliminated if you can prove that:

• You'd have no means of maintaining a basic or reasonable standard of living if you were to be compelled to make loan payments

• The hardship involved in repaying your loans will last for the bulk of your loans' repayment period/your financial situation is unlikely to change for the bulk of your repayment period

• You've made a reasonable effort to repay your loans already

Because the above factors are somewhat open to interpretation, it can be difficult to succeed in wiping out your student debt under Chapter 7. For example, the definition of a "reasonable" standard of living can vary from one court to another. Similarly, proving that your finances won’t improve over an extended period of time can be difficult unless you have a documented medical condition that clearly impedes your ability to work. This especially holds true if you’re relatively new to the workforce, since a court might argue that your income will rise over time, thereby making it possible to pay off your student debt eventually.

As such, if your primary goal in filing for bankruptcy is to get some student debt relief, it might pay to pursue a Chapter 13 filing instead. Under Chapter 13, you’ll be compelled to make court-approved payments toward your loans that may be far more manageable than what you’re liable for under the terms of your original loan agreement.

Usually, Chapter 13 debt repayment plans last three to five years, so during that time, you’ll make your student loan payments as dictated by the court overseeing your case. During this time, your lenders can’t come after you for more money, and you won’t risk having your wages garnished -- a consequence you might otherwise face by falling behind on your loans and not having the protections afforded by a bankruptcy filing.

Should you file for bankruptcy if you're struggling with student debt?

When you're drowning in student debt, filing for bankruptcy might seem like a good solution, but actually, it can be a very stressful, drawn-out process. A Chapter 7 filing, for example, can take six months or more to complete, while a Chapter 13, as mentioned earlier, can last multiple years as you attempt to repay your debts.

Filing for bankruptcy is also an expensive prospect. You’ll need to cover court costs and attorney fees, which don’t come cheap. In fact, the money you could conceivably spend on a bankruptcy filing could be enough to make a huge dent in your student loans.

Additionally, a Chapter 13 bankruptcy filing will remain on your record for seven years, while a Chapter 7 will stay there for 10 years. During that time, you may struggle to borrow money in the form of a mortgage, auto loan, or personal loan. You may also have a hard time getting approved to rent an apartment, or even, in some more extreme cases, getting a job. Therefore, before you rush to file for bankruptcy in an effort to alleviate the burden of your student loans, it pays to pursue other options for making that debt easier to deal with.

If you took out federal loans, you have several options in this regard. First, you can look into an income-driven repayment plan. Typically, when you graduate college, your monthly loan payments are calculated by taking the amount you owe, applying the interest rate you borrowed under, and breaking that out over a 10-year repayment period. In other words, your income doesn't play a role in dictating what your monthly payments should be. Under an income-driven repayment plan, your monthly loan payments are calculated as a percentage of your income, as opposed to a predetermined amount.

There's also the option to defer federal loans during a period in which you're experiencing a financial hardship. Doing so effectively means hitting pause on your loan payments until you're in a better place financially. In some situations, you'll continue accruing interest on your loans during your deferment period. In other cases, you won't.

The downside of both income-driven repayment plans and student loan deferment is that they could drag out the process of paying off your debt. The upside, however, is that they might enable you to keep up with your payments without having to resort to bankruptcy or face other extreme consequences, like wage garnishment.

Now if you borrowed privately for college, you’ll have fewer options on the table -- but that doesn’t mean your lender won’t work with you in some shape or form. If your lender refuses to budge on the terms of your loan and you stop making payments, your lender risks losing money, so rather than go that route, your lender might agree to let you restructure your loan to lower your monthly payments, or even defer your payments for a limited period of time. Therefore, if you’re struggling with your debt, it certainly pays to reach out and try negotiating.

If your lender won’t budge, you can also try refinancing your student loans. When you refinance any type of debt, you're effectively swapping an existing loan for a new one with more favorable terms. If you're able to refinance to a lower interest rate, you could substantially reduce your monthly payments in the process. You can also refinance to a loan that comes with a longer repayment period than the one attached to your current loan. The downside, of course, is that your debt will drag out for longer, but the benefit is that you can lower your monthly payments by spreading that debt out over time.

Keep in mind that you can refinance both federal and private student loans. However, because federal loans typically come with reasonably low interest rates and offer other borrower protections (like income-driven repayment plans and deferment), refinancing generally makes more sense if you're dealing with private loans.

Get ahead of your student loan problems

Once you reach the point where you’re struggling to keep up with your student loan payments, you should proactively get ahead of the problem, whether it means pursuing one of the aforementioned protections offered by federal loans, contacting your private lender and negotiating more favorable loan terms, or refinancing your debt to lower your monthly payments. Filing for bankruptcy is by no means an ideal solution to the student debt problem you may be facing, and in the majority of cases, it won’t enable you to wipe out those loans anyway.

Even if you pursue a Chapter 13 bankruptcy that allows you to reorganize your student debt, the outcome may not be remarkably different than it would if you were to get on an income-driven repayment plan or negotiate a new repayment plan directly with your lender. As such, you’re better off avoiding the negative consequences of having a bankruptcy on your record, and instead attempting to work out a better system for repaying your student debt on your own.

The Motley Fool owns and recommends MasterCard and Visa, and recommends American Express. We’re firm believers in the Golden Rule. If we wouldn’t recommend an offer to a close family member, we wouldn’t recommend it on The Ascent either. Our number one goal is helping people find the best offers to improve their finances. That is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.