Although bankruptcy is a valuable tool, it rarely erases student loan debt completely. In most cases, the obligation to repay student loans remains despite filing a Chapter 7 or Chapter 13 bankruptcy.
In rare cases, a debtor may be able to receive a hardship discharge, which will completely eliminate his student loan debt. If the debtor requests a hardship discharge, he must meet very stringent guidelines to show that requiring repayment of the student loans in his specific case would cause him undue hardship.
Even if a debtor is not eligible to discharge his student loan debt by filing for bankruptcy protection, he is exempt from collection activity on the loan during the pendency of the bankruptcy case. Once the bankruptcy is filed, an automatic stay becomes effective. This stay prevents anyone from taking collection action against the debtor until the case is finalized.
Impact on Interest
Although collection activity is frozen because a debtor filed for bankruptcy protection, interest will continue to accrue, even while the bankruptcy is pending. Therefore, the student loan balance will eventually be higher due to the accrued interest.
In some cases, interest on a student loan may be excused, even though the loan principal is not dischargeable in bankruptcy proceedings. Whether student loan interest is ultimately forgiven depends on the particular bankruptcy chapter that is filed, as well as various other elements in his particular case.
Bankruptcies under Chapter 7 and Chapter 13 have different requirements.
Impact to Student Loans Under Chapter 7 Bankruptcy
During a Chapter 7 bankruptcy proceeding, the debtor’s assets are sold and any debts are satisfied from the sales proceeds in a manner set forth in the bankruptcy code, which is determined by the order of liens, rather than the debtor’s preference.
The older debts, which are classified as “senior debts”, may be the only debts satisfied due to the amount of debt compared to the value of the debtor’s assets that are sold. Student loans are usually identified as senior debts. Therefore, they are a priority in being paid.
Impact to Student Loans Under Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy proceeding, the debtor enters into a plan to reorganize his debts and then makes payments over the course of several years and only repays a portion of his total debt.
The payment plan creates new requirements for the debt repayment. Each creditor must consent to the payment plan and the Court must approve it. While it is not likely to obtain a complete discharge of the student loan, it is likely that the student loan will be reorganized by the payment plan. As a result, the debtor’s monthly payment will be reduced to an affordable amount.
In addition, a deferment of payments might be allowed during the duration of a debtor’s unemployment. Finally, fines and penalties for late or missed payments may be waived.
Although it would be ideal for a Chapter 7 or a Chapter 13 bankruptcy proceeding to totally eliminate student loan debt, a total discharge in bankruptcy of student loan debt rarely happens. It is more likely that a student loan is paid first as a senior debt in a Chapter 7 bankruptcy proceeding or paid through installments in accordance with a payment plan in a Chapter 13 bankruptcy proceeding.
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If you feel bankruptcy is the best option for your financial situation you need to speak with an experienced bankruptcy lawyer as soon as possible. Please contact us online or call our office directly at 888.348.2616 to schedule your free consultation.