Bankruptcy and Student Loans
Updated: May 16, 2020
There are a lot of articles about whether and how student loans are dischargeable in bankruptcy.
This isn't one of them.
Instead, this article will talk about how Chapters 7, 13 and 11 treat student loans in bankruptcy if they aren't dischargeable.
Chapter 7 can be overlooked as an option for dealing with student loans, particularly if you have assets. The Chapter 7 Trustee will gather and liquidate all non-exempt assets and distribute them to creditors, including student loan creditors who file claims. One small advantage of a Chapter 7 is that, due to the logistics of administration, even a small Chapter 7 case may be kept open for a year or two just to administer just a few thousand dollars. Even though you receive a discharge after about four months, the case is kept open during administration and, during this period, the automatic stay remains in effect as to the administered assets, protecting them from collection actions. Post-discharge, however, wages and assets that are not being administered are fair game for student loan collectors, making Chapter 7 of only limited help for most with student loan issues.
Chapter 13 is the chapter most often chosen for dealing with student loan cases, for several reasons:
1. Five Year Stop of Collection Activities (Including Garnishment): A Chapter 13 Plan can last for 5 years, during which time the automatic stay -- which prohibits all attempts from creditors to collect loans from you or your assets -- is in effect and creditors cannot engage in collection activities. This means that they cannot send bills or letters, sue, garnish, attach, or take any collection efforts against you during this five-year period.
2. Disposable Income Plan: Under a Chapter 13 case, you are required to pay "disposable income" -- that is, net income left after payroll deductions, rent or mortgage payments, car payments, food, utilities, insurance, etc. -- towards the Chapter 13 repayment plan. Where there is very little disposable income (as is the case for many of my clients), creditors receive very little in the way of payments. Since student loans do not have to be paid in full through the Chapter 13 Plan, so long as you pay what little is left from your paycheck after paying your living expenses for 5 years, the student loan hounds are kept from the door for the duration of the Plan.
3. Co-Debtor Stay: Under certain circumstances, collections against a co-signer or guarantor of "consumer debt" are also stopped, by the "Co-Debtor Stay" of Section 1301 of the Bankruptcy Code.
4. "Perpetual Chapter 13": Upon the completion of a Chapter 13 and the receipt of a discharge (or even if there is no discharge), you can turn around and file a brand new Chapter 13, with a brand new automatic stay, and another 5 years during which time the student loan creditor cannot call, sue, garnish or attach. This is a very common procedure to deal with student loan debt. We call it a "perpetual Chapter 13," filing a new case every five years to allow you to survive. It doesn't fix the problem, but it does protect you from collection efforts.
Chapter 11 offers all of the advantages of a Chapter 13 (except for the co-debtor stay), with the addition of being able to extend the repayment term for student loans for up to 20 or 30 years, instead of the maximum of 5 that Chapter 13 offers. It also lets people who can't qualify for a Chapter 13 because of the amount of their debt to protect themselves from student loan creditors. As of May 2020, a Chapter 13 debtor can't have more than $419,275 in unsecured debt, or more than $1,257,850 in secured debt (the numbers change every few years). What are the disadvantages? Cost, for one. The legal fees for a typical individual Chapter 11 case are much higher than for a Chapter 13. The filing fee alone is $1,717, instead of the $310 Chapter 13 fee. And the confirmation requirements, including creditor voting and the Absolute Priority Rule, can be problematic. Nevertheless, I have dealt with some very large student loans in individual Chapter 11 cases, and they can be a valuable tool in appropriate cases.