Student Loan Debt: “Undue Hardship” Discharges and
Chapter 13 Bankruptcy Can Help
by Richard Fonfrias,
J.D. Chicago’s Financial Rescue &
Fonfrias Law Group, LLC
Student Loans Can Be Erased in Bankruptcy – But It’s Not Easy
To discharge your student loan in bankruptcy, you must show that making the loan payments “will impose an undue hardship on you and your dependents.” If you prove “undue hardship”, then your entire student loan will be eliminated.
The test for whether the court will cancel your student loan requires that you prove that (1) if you are required to pay your student loan, you cannot maintain a minimal standard of living for yourself and your dependents; (2) your current circumstances are likely to continue for much of the student loan repayment period; and (3) you have made an reasonable effort to repay your student loan.
Examples of people who had student loans cancelled because of “undue hardship” include these:
1. Student Loan Discharged – for a 50 year old student who earned $8.50 per hour as a telephone marketer. The court found that the person did not earn enough money to pay the loans and pay his family’s expenses, nor did it look like he would be able to break his cycle of poverty.
2. Student Loans Discharged. Often courts have canceled loans for students whose education did not benefit them or who attended schools that were fraudulent.
3. Student Loans Discharged – for a married couple whose income was just above the poverty level. Even though they were college educated, they had chosen low-paying careers and their expenses exceeded their income. As a result, relatives helped pay expenses. The court found that the couple acted in good faith because they had asked for a more affordable repayment plan, which was denied.
4. Student Loan Discharged – for a woman whose mental impairment convinced the court of her undue hardship. Further, the court agreed that her mental illness would continue to hurt her ability to work.
Chapter 13 Stops a Lender’s Attempts to Collect on Your Student Loan
Before filing bankruptcy, you should try to get the lender to modify your student loan so its terms fit your budget. If the lender won’t hear of it, then a Chapter 13 bankruptcy will help reduce the pressure on you with a payment plan you can afford.
When you file bankruptcy, the court issues an “automatic stay”, which means no creditor can continue collection efforts on any money you owe. This means your student loan lender cannot take any collection action against you. This includes garnishing your wages and seizing any of your assets. This automatic stay remains in force for the entire time your chapter 13 plan is in effect, from three to five years. This is true even if your payments are not enough to repay your student loan.
Student Loans in Bankruptcy
When you or your lawyer files a Chapter 13 bankruptcy, here’s what happens:
1. Your student loan debt is not erased. However, during bankruptcy, if you are not able to pay on your student loan — and if you don’t expect to be able to pay on it in the future — it could be discharged in your bankruptcy.2. Your student loan debt does not get any special priority in bankruptcy. Debts such as child support and taxes get priority treatment in bankruptcy. This means they are paid before other debts. But your student loan debt does not get priority treatment, which means some of the loan balance may still be due after your chapter 13 repayment plan ends.3. Your student loan debt has the same priority as credit cards and other unsecured debt. During Chapter 13 bankruptcy, if you can pay $200 per month to unsecured creditors, then that money is divided among all of your unsecured debts, including credit cards, medical bills and your student loans.4. Some bankruptcy judges treat student loan debt a little differently from other debts, but this is rare. For example, they may require that the trustee
- pay your student loans before paying other unsecured debts, such as your credit cards and medical bills;
- pay more on your student loans than other unsecured creditors; or
- pay your student loans separately and not as part of your chapter 13 repayment plan.
Here’s What Happens to Your Student Loan During Your Chapter 13 Repayment Plan
Your chapter 13 bankruptcy allows you to pay only what you can afford on your student loans and other unsecured debts. And in some cases, Chapter 13 might cause your loan balance to increase. Here’s what could happen:
1. You could pay off your student loan in full if you don’t have much other unsecured debt.2. You might increase the amount of your student loan debt. During your chapter 13 bankruptcy, the interest on your student loan continues to add up. So if your bankruptcy payment is not enough to pay that interest, the amount of your student loan could increase during your bankruptcy.3. Even if you can pay only a small amount to unsecured creditors, your bankruptcy takes the pressure off of you by stopping all of your creditors’ collection efforts. This gives you time, for example, to get a good-paying job or to erase other debts at the end of your repayment plan.
If You Want to Pay as Much as Possible on Your Student Loans…
Here are steps you can take.
1. File a Chapter 7 Bankruptcy to erase other unsecured debt. You might qualify to file a Chapter 7 bankruptcy. If you do, and if you have a lot of other unsecured debts, you could file two bankruptcies. First, a chapter 7 to erase your unsecured debts. Then, a chapter 13 so you pay as much as possible on debts that cannot be discharged. All this time you are still protected by the court’s automatic stay, and your Chapter 7 has erased your credit card and medical bills.
2. If the bankruptcy court permits it, you could exclude student loans from your chapter 13 plan. While this is rare, a few bankruptcy courts will allow you to pay your current student loans outside of your chapter 13 repayment plan. At the same time, you can catch up on your student loan’s back payments through your bankruptcy. This does not happen often, however.
3. The bankruptcy court may allow you to treat your student loans differently depending on your situation. If you need your income to make your chapter 13 payments, which you probably do — and if you could lose your professional license if your student loans payments are late, which would cause your income to stop, the court may allow you to treat your student loans differently.
When Your Chapter 13 Repayment Plan Ends
At the end of your Chapter 13 plan, if your student loans are not paid in full, then you will have to keep making those payments even after bankruptcy. As you near the end of your chapter 13 repayment plan, you might be able to work with your student loan lender to set up a new payment plan. If you made your regular payments during your chapter 13 plan, the lender might work with you. And since your other unsecured debts will be discharged at the end of your repayment plan, you will have more money available that you can apply toward your student loans.
How Chapter 13 Helps You With Your Student Loans
1. Your Chapter 13 repayment plan will either erase or pay off all of your other unsecured debt. This means you’ll be able to apply more money toward your student loans after your Chapter 13 ends.
2. Your chapter 13 can buy you a little time during which you can find a new job, get other unsecured debts erased, reduce your living expenses and get your finances in order.
3. Your chapter 13 and its 3-5 year relief due to the automatic stay, gives you relief from burdensome monthly payments.
4. Your chapter 13 plan pays your student loan creditors the same as other unsecured creditors. If your loan debt makes up most of your unsecured debt, you could pay more than the amount of interest that has added up.
5. You can file a chapter 13 bankruptcy even if you are not allowed to discharge any debt because you have filed too soon after a chapter 7 or chapter 13 bankruptcy. While this won’t allow you to erase any debt, it will give you another 3-5 years to pay whatever you can afford toward your student loans and force the lender to accept whatever you can pay. Plus, you can file an additional chapter 13 bankruptcy to buy even more time until your student loans are fully repaid.