Relief from student loans through bankruptcy is limited. Generally, you cannot discharge (or wipe out) a student loan without showing extreme hardship. Chapter 7 bankruptcy and Chapter 13 bankruptcy may help you by dealing with other debt leaving more money available to pay the student loan.
Student Loan Debt Bubble
Student loan debt surpasses all revolving debt, clocking in presently at over a trillion dollars! It’s the new debt of choice to be sure. It’s important that every student and parent understand their loan not only before it’s borrowed, but when it’s time to repay. Various resources for learning about your student loan are available:
- US Dept of Education has an informative website giving details about the types of loans available
- National Consumer Law Center Student Loan Project helps you work through various options for resolving student loan issues.
If the main debt problem is a student loan, bankruptcy may help, but will not usually wipe out the loans. To discharge student loans through bankruptcy, you must prove hardship.
The treatment of student loans in Chapter 7 bankruptcy is simple. They are not discharged unless an action is brought and the borrower is able to meet an extremely high burden of proof that payment of the student loan will result in hardship. Discharging other debt can be helpful though as it can free up funds to pay the loans.
In Chapter 13 bankruptcy, the way a student loan is handled varies. Generally student loan debt is treated like a general, unsecured debt. The student loan is paid the same pro rata share as other general, unsecured debt. If the individual is fortunate enough to be in a 100% Plan (where they are earning enough money to afford to pay back all of the debt over the term of the Plan with interest), the Court may allow the student loan to be paid directly. In some cases, the Court may permit student loans to be paid directly as long as the student loan payment doesn’t result in the student loan creditor getting more than their share of the “pot” of money available to general, unsecured creditors. This may be important if you are eligible to discharge the loan under a non-bankruptcy program such as Public Servant Forgiveness.
In most cases, at the end of the bankruptcy, the borrower will still owe the student loan with interest. However, the bankruptcy does keep the student loan lender from assessing penalties or collection costs while the bankruptcy is pending. In some circumstances, a Chapter 13 bankruptcy may help. If the student loan payment is too large to handle, a Chapter 13 bankruptcy may lower the person’s overall debt payments enabling the individual to live and meet basic bills while in bankruptcy. But there are many repayment programs available for federal loans. Again, the problem is that without a hardship discharge, the student loan doesn’t go away and grows in bankruptcy. If a debtor’s main problem is federal student loans, the first thing to look at is repayment options.
Overview of Student Loans
Federal or Private
In the broadest terms, there are two types of student loans–federal and private. Federal refers to the main federal loan programs offered for current students which includes the Stafford Loan and Federal Perkins Loan.
The Stafford Loan has two variations. The first variation is the Federal Family Education Loan Program (FFEL). These are student loans offered by private lenders such as banks and credit unions. These loans are guaranteed by the US government but the lender originates the funds. FFEL loans have been discontinued since July 2010. The other variation, and the only option available after July 2010, is the Federal Direct Student Loan Program (FDSL). These are simply referred to as “Direct Loans” because the US government is the direct funder of these loans. Direct Loans are the most popular for current students and parents. Also falling under the Direct umbrella are PLUS loans (for parents or graduates) and Consolidation loans.
The Federal Perkins Loan is for students with exceptional financial need and are administered by the participating school. The school is given a limited pool of funds by the government and the school acts as the lender.
Private student loans, on the other hand, are a different beast. These are loans that look, smell, taste, and act like a federal loan, but they are fundamentally and detrimentally different. People take out private student loans when there just isn’t enough money provided after the federal loans limits are reached. Unfortunately, some of the private lenders have names that sound awfully governmental, but that couldn’t be more misleading. Further, some lenders that offer the FFELP loans mentioned above also offer private student loans, so it can be even more difficult to sort through.
Finding out the Loan Type
When exploring options for repayment or relief, the first step is to understand and know what type of loans the student or parent took out. There are two main ways the student can figure out what type of loan they have. Look up the loan on the National Student Loan Data System. If it is found here, then it is a federal loan.
Find the loan documentation. The promissory note will name the federal loan program at the top (Stafford, PLUS, FFEL, William D. Ford Direct Loan Program, etc.) The student or parent may also be able to find this information on the monthly bill or contract. It’s possible that the school may assist with obtaining this information as well.If the loan is not a federal loan, then that leaves only one option–a private loan.
Non-Bankruptcy Repayment Options
The options available for repaying or otherwise obtaining relief from student loans vary widely depending on whether the loan is public or private, the current status of the loan (whether or not the loan is in default), and the amount owed.
These options are not only confusing to sort through, but it can be difficult to know if the loans qualify for certain repayment options. The options listed below and their descriptions are certainly not meant to be comprehensive. There are volumes of laws written the govern student loans and certain details can make a loan eligible, or it can disqualify just as easily.
There is a maze of options and criteria. The first step is to determine what options are available. Some of the available options include:
Standard Repayment – This repayment option is a fixed monthly payment based on a 10 year repayment term. The payment term can be shorter, however, as the minimum payment under this plan is $50 per month. Eligible loans are Direct Loans, Stafford Loans, and all PLUS loans.
Graduated Repayment – The plan differs from the Standard plan in that payments are lower at first, and gradually increase, usually every two years. The idea is that the borrower will get better, higher-paying jobs or raises as more time goes on. The term of repayment is 10 years. Total interest is higher than the Standard plan. Eligible loans are Direct Loans, Stafford loans, and all PLUS loans.
Extended Repayment – This can be similar to both the standard and graduated. Essentially, it takes either the Standard or Graduated plan, and extends the time to between 12 and 25 years, depending on the balance. In other words, the borrower can extend the time to pay and choose either fixed payments or graduated payments. In addition to some other qualifications, a borrower must have more than $30,000 in Direct or FFEL loans to qualify. Eligible loans are Direct Loans, Stafford loans, and all PLUS loans.
Income-Based Repayment (IBR) – This plan is perhaps the most relief-giving. The maximum monthly payment will be 15% of discretionary income above 150% of poverty level. Discretionary income is defined as the difference between the adjusted gross income (AGI from the tax return) and 150% of poverty level for the household size and state of residence. Payments go up and down as income goes up and down. The remarkable part of this plan is that after 25 years of income based repayments (10 if the borrower works for a qualified institution, like a public school), the loan balance and any accrued interest is forgiven. Eligible loans are Direct Loans, Stafford loans, all PLUS loans, and Consolidation loans that do not include loans made to parents. The forgiven portion could be taxable.
Pay As You Earn Repayment (The New IBR)– There have been several legislative actions, including the Health Care and Education Reconciliation Act of 2010, that essentially modified IBR from 15% to 10% of discretionary income and shortened the forgiveness period from 25 years to 20 years. Eligible borrowers are those that were new borrowers on or after October 1, 2007, and must have received a disbursement of a Direct Loan on or after October 1, 2011. Eligible loans are Direct Loans, Direct PLUS loans made to students, Direct Consolidation loans that do not include loans made to parents.
Income-Contingent Repayment (ICR) – This is perhaps one of the most confusing payment plan. This plan using an extremely complex formula that inputs variables like income, family size, and loan balance, and spits out a term and payment amount. Like IBR, after 25 years of ICR payments, the loan balance and interest is forgiven but could be taxable. Eligible loans are Direct Loans, Direct PLUS loans made to students, and Direct Consolidation loans.
Income-Sensitive Repayment (ISR) – This payment plan is an alternative to ICR for FFEL lenders can offer borrows ISR, which links payments to income. The loan term is 10 years. Eligible loans are Stafford Loans, FFEL PLUS loans, and FFEL consolidation loans.
Check with the lending school for repayment options available. If a Perkins loan is consolidated, then some of the above options may be available, such as Income-Based Repayment.
There are no special repayment options for private student loans. There are two options: pay according to the terms of the note or don’t. When a private loan is taken out, the repayment terms will be listed in the promissory note. If the borrower fails to perform according to this contract, then the lender has remedies provided by state law. Most often, this includes getting sued.
If a borrower is sued and the lender obtains a judgement, the lender could levy bank accounts and attempt to take any unexempt property.
Loans in Default
Understanding default is important. Federal student loans are perhaps one of the most dangerous types of debt on which to default. It ranks with taxes or child support in regards to the reach of the creditor. They have special rules and regulations that allow them much more power than “regular” debts like credit cards or medical bills.
The first day the loan payment is past due, the loan is considered delinquent. After 90 days of delinquency, the loan servicer will begin to report to the credit bureaus of the delinquency. After 270 days of delinquency, the loan will be declared to be in default.
Possible Consequences of Default
- The entire balance of the loan becomes due
- The borrower loses the “benefits” of the federal loan repayment options, forbearance, and loan deferments
- The borrower can not borrow anymore student loans
- Tax refunds can be withheld to pay on the loan
- Fees, penalties, and interest begin to stack up
- The borrower’s wages can be garnished
- The lender can take legal action
The Department of Education offers extensive information regarding rehabilitating a student loan including:
Loan repayment – One option, obviously, is to pay the loan balance in full. As if this was actually an affordable option!
Loan rehabilitation – Essentially, rehabilitation is a “trial period” that is agreed upon by the borrower and the lender. The borrower will make payments that are deemed “reasonable and affordable” for a selected period of time. Once the timely rehabilitation payments have been made, the default status will be removed. Eligibility of benefits return such as repayment options, forbearance, loan forgiveness, and borrowing more student loans.
Consolidation – A defaulted loan can be cured through consolidation, if eligible. The defaulted loan is paid off by a new consolidation loan. Eligibility, among other things, included requiring the borrower to pay several voluntary, on-time payments consecutively. Usually, three payments are required prior to the consolidation loan being issued.
Your Next Step to Debt Relief
If you are struggling with debt, consult with an attorney who can give you guidance on options available to you. Each case is different and consultation with an attorney knowledgeable about the law as it applies to your particular circumstances is an important first step in resolving debt.
Read More About Bankruptcy and Debt Relief
Chapter 7 – Usually the cheapest and fastest type of bankruptcy, Chapter 7 can wipe out credit cards, medical bills, and loans.
Chapter 13 – Does everything that Chapter 7 does, but with the added benefit of being able to help catch up on past due mortgages, car payments, and taxes.
Taxes – If you owe money to the IRS, there may be several different options for you, including some non-bankruptcy options.
Student Loans – There are many solutions to student loan issues, including getting a better payment plan, curing a default, and even loan forgiveness.
Debt Lawsuit Defense – When a creditor sues you over a debt, you can respond with a defense, which may allow you to win the lawsuit.
Loan Modifications – A special agreement between you and your mortgage lender might help you with a past due mortgage loan.
Debt Library – More in-depth articles on some of the more detailed areas of bankruptcy and debt relief.