Using Chapter 13 Bankruptcy to Manage Student Loans

Although you can wipe out many types of debt in bankruptcy, getting rid of student loans is difficult. But even if you can't "discharge" or wipe out your student loans through bankruptcy, you can often use Chapter 13 bankruptcy to help manage otherwise high student loan payments.

Student Loan Discharging Difficulties

In bankruptcy, you can usually discharge unsecured debts like credit card debt, medical bills, and personal loans. Student loans are also unsecured debts, but bankruptcy treats them differently. Unlike most, you can't automatically discharge them in Chapter 7 or Chapter 13 bankruptcy.

Discharging student loans in bankruptcy can't be done without filing and winning a separate lawsuit called an "adversary proceeding." At trial, you must show the court that paying your student loans will cause you or your dependents hardship. The standard for proving a hardship will depend on your jurisdiction, but it's always difficult to overcome.

Managing Student Loan Payments With Chapter 13

Even if you can't use bankruptcy to eliminate your student loans, you might be able to use Chapter 13 bankruptcy to reduce the amount you pay on your student loans for the length of your bankruptcy case, usually 36 to 60 months.

A Chapter 13 case differs from Chapter 7 because you keep all property. In return, you must devote your "disposable income"—the amount remaining after deducting allowed monthly expenses—to the repayment of debts over the life of your plan.

After the court approves a Chapter 13 plan, you pay the agreed amount monthly to the Chapter 13 trustee. The payment amount depends on several factors, such as your property, income, and reasonable and necessary expenses. The trustee distributes this payment among your unsecured creditors on either a priority basis (creditors receive full payment) or a pro rata basis (the lowest priority creditors receive the same payment percentage).

Example. Suppose you make $3,000 per month. Your rent, car payment, utilities, food, and other household expenses total $2,700 monthly, giving you $300 in disposable income. If you weren't in Chapter 13, you would also pay $400 in student loans and $300 toward credit card minimums and medical bills, leaving you short each month by at least $400.

However, in Chapter 13 bankruptcy, all unsecured creditors you'd typically pay a total of $700 per month to would share your $300 monthly disposable income. The trustee would distribute it to your unsecured creditors, including your student loan lender, pro rata. You could afford the required payments instead of being down $400 each month.

Keep in mind that calculating your Chapter 13 plan payment is more complicated than the above example. You can get a quick estimate of your Chapter 13 payment using a Chapter 13 calculator, but you won't want to rely on it. It's essential to consult a bankruptcy attorney for an accurate amount of what you'd pay in Chapter 13.

The Chapter 13 Trustee and Student Loans

As you make your monthly payments to the Chapter 13 trustee, the trustee will forward a portion of your plan payment to your student loan lender. Whether that money will reduce your principal or only cover interest will depend on the terms of your loan. Interest will continue to accrue on your student loans while you are in Chapter 13.

After Chapter 13 Bankruptcy

At the end of the Chapter 13 plan period, your bankruptcy will discharge the remaining amounts you owe on qualifying debts, like credit cards, medical bills, and other unsecured debts, even if you don't pay those claims in full through your Chapter 13 plan.

However, the bankruptcy case won't eliminate your remaining student loan debt. Your lender will recalculate your payments based on your loan balance at the end of your case and set up a new payment schedule. You might be better positioned to afford your student loan payments after discharging other debt in Chapter 13.

Student Loan Repayment Programs in Chapter 13

Being in Chapter 13 doesn't limit your ability to apply for other student loan assistance programs or to seek consolidation or rehabilitation of student loans. If you qualify for another program that changes your loan terms, you might have to do one of the following:

Modify your Chapter 13. If the new student loan payment plan is less than the amount your lender receives through the Chapter 13 plan, talk with your lawyer about reducing the amount paid through the plan or other options.

Dismiss the Chapter 13 case. If your new student loan payment is reduced or eliminated, you might not need Chapter 13 any longer. If you dismiss the Chapter 13 case, your debts won't be discharged, and you'll remain liable for unpaid amounts. If you qualify for Chapter 7, consider converting to Chapter 7 and quickly discharge your other debts. Learn more about converting Chapter 13 to Chapter 7.

Warning for People in Income-Dependent Programs

Many student loan programs offer to cancel the debt obligation after a number of years—usually twenty to twenty-five. You'll want to determine if you'll receive credit towards those years while in a bankruptcy case before proceeding with Chapter 13. In the past, filers have lost credit for previous payment years. A local bankruptcy attorney should be able to help you find the answer.