For Some Filers, Bankruptcy Can Actually Increase Student Loan Debts

Many people find that bankruptcy is a godsend; it allows them to discharge debts and begin rebuilding their financial lives. However, for those burdened with student debt, the protections offered by the Bankruptcy Code can be a false paradise.

Student loan debt typically survives bankruptcy

For those struggling with most types of unsecured debt - financial obligations like credit card debt or medical bills that are not tied to physical assets - bankruptcy can be an attractive solution. When it comes to student loans, however, bankruptcy can not only be ineffective, it can even wind up leaving filers in a deeper financial hole.

A number of years ago, lawmakers enacted reforms to the Bankruptcy Code that make it very challenging to discharge student debt through bankruptcy. These reforms were meant to curb what was seen as abuse of the system when recent college grads would immediately file for bankruptcy without ever attempting to repay loans.

Today, student debt may only be discharged in bankruptcy if repayment obligations are causing "undue hardship." To show undue hardship, a bankruptcy filer must prove:

• Repayment of the loan would prevent the filer from maintaining "a minimal standard of living."

• Long-term hardship beyond the filer's control (often disability-related) is likely to continue during the loan repayment period.

• The filer tried in good faith to repay the loan (typically meaning payments have been made for a minimum of five years).

Meeting all of these requirements is difficult; filers are very unlikely to get student debt discharged in bankruptcy.

Making partial payment on student debt during bankruptcy means higher fees

Failing to get debt discharged is one thing, but in some cases bankruptcy can even make student debt worse.

In a Chapter 7 bankruptcy, filers qualify for an almost immediate discharge of debt, but will have to give up assets if they have valuable property that does not fall under an exemption category. Chapter 13 bankruptcy filers, on the other hand, have debts consolidated, often with payments reduced, and make partial repayment over a three to five year term, typically without having to surrender any assets. At the end of the term, most types of remaining debt are discharged, but student loan debt is a notable exception.

Student loan repayment obligations typically remain intact after either type of filing. Chapter 13 can be particularly problematic, however, and given the income limits for Chapter 7, many of those with student loans cannot qualify for Chapter 7.

During a Chapter 13 case, different types of debt are prioritized with portions of the filer's payments allocated accordingly. Creditors can appear in court and advocate for a greater proportion of the "pie." Many times, this means that full payments are not made on a filer's student loan obligations during the three to five year repayment term. Most debts are discharged at the end of the term, but student loans are not. While student loan creditors are only receiving partial payments on outstanding debt during those three to five years, they may tack on penalties, late fees and interest that cause student debts to balloon to levels higher than before the bankruptcy.

Ask a bankruptcy attorney about the best solutions to your debt problems

Bankruptcy is still a good solution for some people with student loans, such as those with large outstanding obligations on other types of unsecured debt. Of course, each bankruptcy case is unique, and only a qualified bankruptcy attorney can offer advice on whether bankruptcy is appropriate given your individual circumstances. If you are facing burdensome debt, ask an experienced bankruptcy attorney about the best course of action.