If you suffer from large student debt, you may wonder how bankruptcy and student loans work. In this guide, we’ll explain everything you need to know.
As America sees a transition of power this January, it also experiences the dire need for economic stimulus due to the Covid-19 pandemic.
With over $1.6 trillion in outstanding student loan debt, the incoming Biden administration faces pressure to forgive student loans. Whether any actual student loan forgiveness legislation or executive orders materialize remains to be seen.
You may face a mountain of student loan debt and don’t see a way out, and want to know how bankruptcy and student loans work. In this guide, we’ll explain everything you need to know.
A Little History
The history and current severity of the student loan debt crisis tie directly to a law President-Elect Biden championed while serving as the Senior Delaware Senator.
Before 2005, students with outstanding private student loan debt were able to use bankruptcy proceedings to discharge that debt. That’s right, bankruptcy and student loan elimination worked together to relieve debts.
When the Bankruptcy Abuse Prevention and Consumer Protection Act became law in 2005, Chapter 7 bankruptcy became a means-tested proceeding. This made it much harder for struggling Americans to clear themselves of debt.
Hidden in this law was a provision that made student loan debt one of the 10 debts unforgivable through any bankruptcy proceedings. As the lending institutions faced no risk, they started to lend more and more.
As lending institutions were now unbound from the normal risk bankruptcy presents, more money flowed into the system. University and college costs skyrocketed.
As more students enrolled because of this easy money, the debt snowballed.
So now, we have $1.6 trillion in debt that cripples the financial capabilities of borrowers for a lifetime. It will more than likely never be paid back.
Student Loans and Bankruptcy Ch. 7
Your debt puts you underwater. The debt collectors hound you for a pound of flesh you can’t give. It’s impossible to get a decent night’s sleep and no matter how many hours you put in, or how many jobs you work, you can’t get ahead.
With all that regular debt comes your mountain of student loan debt, that despite regular payments, keeps growing larger and larger thanks to compounding interest. This kind of stress can drive you crazy.
You might be thinking of filing for Chapter 7 bankruptcy. While this might be the right financial plan for you, if you carry a load of student loan debt, a bankruptcy judge more than likely won’t discharge this debt.
More than likely doesn’t mean not at all. You stand a chance of discharging your loans through bankruptcy if you can prove they present you with an “undue hardship” in a separate proceeding.
You’ll have to take the Brunner means test. This three-part test helps a bankruptcy judge determine whether your student loan debt keeps you from a “minimal” standard of living.
Unfortunately, these bankruptcy cases don’t often result in a discharge. Because of the restrictions found in the 2005 BAPCPA legislation, a student loan forgiveness bankruptcy is hard to achieve.
Chapter 13 Bankruptcy and Private Student Loans
Chapter 13 bankruptcy works differently in terms of student loan debt than Chapter 7, though the debt is still not automatically forgiven. When deciding which type of bankruptcy suits your needs best, you’ll need to consult a bankruptcy attorney.
When you file Chapter 13, your debtors will stop hounding you. An automatic stay granted from the court prevents this. Once this happens, the court considers your student loan debt as nonpriority debt.
Under this classification, you will have to pay your debt, but only a portion during the three to five year Chapter 13 repayment plan.
That sounds like a great strategy, right? Not so fast. During this period of reduced payment, your loans may still accrue interest. Once the bankruptcy period ends, you may have to pay the remaining balance.
This is because student loans often fall into the category of non-dischargeable debt like child support and back taxes.
Bankruptcy and Student Loan Forgiveness
While it is possible to discharge your student loan debt through bankruptcy, it’s not common. The current bankruptcy laws don’t allow for it. So what do you do?
There are options available for you to reduce the financial hardship your student loans present.
Income-Driven Repayment (IDR)
These payment plans cover Federal Student Loans. With an IDR plan, you can make payments each month based on your income. These various payment plans drop your payments to around 10% of your monthly income.
After 20-25, you receive loan forgiveness. While these are great perks, these plans have their downsides. To qualify for loan forgiveness, you must make all your payments on time. If you miss a payment or pay late, you are disqualified.
Another IDR catch is that your loans will continue to accrue interest. Your low payments mean your loan amount may grow larger. Should you qualify for forgiveness at the end of the term, you will be taxed on the amount forgiven.
Forbearance or Deferment
If you face acute financial struggles like the loss of a job or a divorce, you can apply for a forbearance or deferment of your loans. This is a temporary pause on your payments that give you time to get back on your feet.
With a deferment, your loans will not accrue interest. With a forbearance, the interest will accrue. While these are good short-term financial strategies, they get you nowhere in terms of eliminating your debt.
This allows you to group your debt to lower your interest rate. You can do this with most federal loans. If you carry a lot of private student loan debt, some restrictions don’t allow for them to consolidate with federal loans.
Once you lower your interest rate and enroll in a payment plan, you could be on your way to student debt elimination.
Bankruptcy and Student Loans
There’s good news and bad news when it comes to bankruptcy and student loans. The good news is that it is possible to discharge your debt through bankruptcy, though it is not common.
There is more hope on the horizon. Legitimate momentum behind student loan forgiveness may mean future legislation or executive orders. Until then, explore all your options including consolidation and IDR plans.
Are you in debt and can’t see a way out? Husker Law is here to help you. Call (402) 415-2525 today for a consultation.