Many student loan borrowers, carrying an average of $30,000 in federal-guaranteed and private student loans, have a hard time finding the income in the midst of a weak economy to make the large payments after graduation. While Chapter 7 of the Bankruptcy Code allows for a hardship discharge of student loan debt, proof of that hardship is extremely difficult, if not impossible. However, Chapter 13 of the Bankruptcy Code may provide an avenue to restructure the student loan according to your budget.
Federally-guaranteed student loans have many programs available to restructure payments according to your ability to pay, but private student loans are different. Private lenders can be more aggressive about debt collection and their loans will typically have higher interest rates.
Filing for Chapter 13 allows the borrower to make payments based on the ability to pay for a period of up to five years. It can give borrowers some breathing room from private student loan debt that they may not have been able to obtain otherwise. But that plan does have some downsides. Interest continues to accrue and the payments during the plan might not do much to reduce the balance. Then when the plan ends, the payments may return to their original level.
"Borrowers may need this strategy for private loans, but shouldn't file a Chapter 13 for federally-guaranteed loans because of IBR (the income-based repayment program)", says Joshua Cohen, a student loan attorney who teaches bankruptcy attorneys how to deal with private loans in and out of bankruptcy.
But can this strategy be used long-term to restructure your student debt over more than just five years?
“Theoretically, Chapter 13 cases can be filed back-to-back, perpetually keeping the private student loans at bay for a long time. So far, no court has held that it is a bad-faith method of dealing with this insurmountable problem. Since the loans are not discharged, the budget plans can assist in proving that the loans fit the hardship definition created by the bankruptcy courts,” says Cohen.
It’s important to note here that repeat bankruptcy filers are not eligible for a discharge of debts unless there are at least two years between the filing dates of Chapter 13 cases, but because student loans are not generally dischargeable absent proof of a hardship anyway, the need for a discharge in a case like this would absent.
Keep in mind that while a Chapter 13 case is proceeding, there is little chance for any new credit, which requires court approval. Bankruptcy will also have an effect on credit scores since it can remain on a credit report for 10 years. However, defaulting on student loans — if that's where you're heading — can also have a big negative impact on your credit, and you may be left to deal with debt collection, lawsuits or possibly even wage garnishment. So it's important to carefully consider your options, and perhaps consult a bankruptcy attorney to see if bankruptcy even makes sense for you.
You can see how your payment history — or a bankruptcy — is affecting you by getting your free annual credit reports, and there are many resources that give you your credit scores for free, including Credit.com. It can also be helpful to keep an eye on these to check your progress as you work to rebuild your credit.
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