Back to School: Student Loans & Bankruptcy

Five of my six kids are headed off to school in the next few days.  It seems like the school years starts a little earlier each year.  There are schools herein Arizona that start in July!  And as focus returns to hitting the books the issue of student loans is on a lot of people’s minds.

Student loan debt in the United States is currently at one trillion dollars.  A trillion!  Do you know what that looks like?  It looks like this – $1,000,000,000,000.  That, my friends, is a serious amount of student loan debt.  Many are predicting that student loans are going to be the next big financial crisis, similar to the mortgage crisis that has crippled the nation for the last four years.

Student loans are relatively easy to get, are often given to young people who are not too concerned with payment of the debt because it is so far away, and they don’t go away in bankruptcy.  Take all these factors together and you are looking at what could be a financial disaster.

On a much smaller scale your student loans may be causing you problems as you try and make ends meet.  It is rare that one of my bankruptcy clients doesn’t have some student loan debt or have even co-signed on someone else’s student loans.  Student loan debt seems to touch us all in one way or another.

So what can you do if you can’t afford your monthly payments? There are various programs that can help you with student loan debt, and I will be discussing those in future articles, but in this article I would like to focus on how filing bankruptcy impacts your student loan debt.

Student Loans & Chapter 7 Bankruptcy

A chapter 7 bankruptcy is a relatively short process.  Here in Arizona it takes about 4 to 5 months for you to receive a discharge of your debts.  Chapter 7 bankruptcy is great for eliminating unsecured debts like credit cards and medical bills.  While student loans are usually an unsecured debt (meaning there is no property attached to them), they generally do not go away in your bankruptcy case.

Loans that were taken out for educational purposes, both federally backed loans and private loans, are not, with a few exceptions, eliminated in bankruptcy.  What a chapter 7 bankruptcy will do is put a hold on any collection efforts the student loan lender may take against you while your chapter 7 case is active.  This means that they cannot garnish your wages or take money out of your bank account.

However, once your chapter 7 bankruptcy case is over the student loan debt will remain and you will be held responsible payment of the debt.

While the presumption is that student loan debt is not discharged in bankruptcy, there are situations where the bankruptcy court can make a determination that they will be eliminated.  If the bankruptcy court deems that it would cause you an “undue hardship” to continue to pay your loans, then all or a portion of them can be discharged in your bankruptcy.  It is rare that some doesn’t believe that be required to continue to pay their student loans causes an undue hardship, but what you think is a hardship and what the bankruptcy court deems a hardship are likely two different things.

The bankruptcy court will to three factors in deciding whether you will be required to pay your student loans:

First. If you are required to pay your student loan debt will you be able to maintain a minimal standard of living?

Second.  Is it likely that your inability to repay your student loan is going to continue for a significant portion of the repayment period of your student loan?

Third.  Have you made a good faith effort to pay the loan in the past?

Pretty straight forward, right?  Before you get too excited, let me tell you about a case that can put things in perspective.  As an intern at the bankruptcy in the District of Nevada I watched the trial of a lawyer that had been paralyzed in a car accident and was seeking to discharge her extensive student loans.  This women was severely  disabled and had limited use of her hands.  After three days of trial the bankruptcy judge ruled that half of her student loans could be eliminated and that the lawyer would be required to pay the other half.  The reasoning?  The judge stated that because the lawyer could still work -albeit with considerable help – that she could still earn an income and still pay a portion of the debts.

So with most courts the bar has been set pretty high.

Student Loans & Chapter 13 Bankruptcy

The same rules apply to the elimination of student loans in chapter 13 bankruptcy cases as they do chapter 7.  However, because chapter 13 bankruptcy is so much longer it creates a situation that may be more advantageous to you.  When repayment starts on your student loans the monthly payment is set by the lender and you are required to pay it.  When you file chapter 13 bankruptcy, while your student loans generally to not go away, the chapter 13 case puts them in a deferment of sorts and you are no longer required to pay the monthly payment directly to your student loan lender.

Your student loans are lumped in with all of your other unsecured debts and will receive a portion of their payment over the three to five years of your chapter 13 case.  Then, upon completion of your bankruptcy you will be required to pick back up with your regular monthly payment.  This can be very helpful to families that are going through a reduction in pay or job loss and can’t afford their student loan payments now but will be able to in the future.  You can significantly reduce your monthly payment for up to five years and then pick back up with it later on when your bankruptcy is over.

As I said earlier, there are also many things and strategies you can take with student loan debt outside of the bankruptcy court.  In the coming weeks I will write an additional article covering those.