Although bankruptcy is not always the best answer to your student loan problems, in some situations Chapter 13 bankruptcy can help. If your loans are in default and you cannot rehabilitate your loans and get on an income based repayment plan (perhaps because of your other expenses), Chapter 13 bankruptcy may help relieve some financial pressure and get you back on track. (To learn about rehabilitating loans and income-based repayment options, visit Nolo's Student Loan Debt area.)
Chapter 13 Stops Student Loan Collection Actions
Something called the automatic stay immediately goes into effect when you file a Chapter 13 bankruptcy. Under the automatic stay, student loan creditors are prohibited from taking collection action against you (for example, they must stop wage garnishments). This collection prohibition continues while you are making payments under your Chapter 13 plan (which lasts from three to five years), even if the payments you make are not enough to pay the student loans in full, or in some cases, at all.
How Student Loan Debt Is Treated in Bankruptcy
Here’s what happens to student loan debt in Chapter 13 bankruptcy:
Debt not discharged. Generally, student loan debt is not discharged (wiped out) in bankruptcy. However, if your financial circumstances are particularly dire and not likely to improve, it may be possible to discharge student loan debt in bankruptcy. (To learn more, see Student Loans in Bankruptcy: The Brunner Test.)
No priority over other debts. Many debts that are not dischargeable in bankruptcy (such as child support and taxes) get special treatment (called priority debts) and are paid before other nonpriority debts. So, for example, your Chapter 13 plan might pay your child support and tax debt in full, while paying only pennies on the dollar on credit card debt. Student loan debt, however, does not get special payment priority.
Student loans paid along with credit card debt. Student loans are treated the same as other nonpriority unsecured debts in bankruptcy. If your budget allows you to pay $300 per month to unsecured creditors in your Chapter 13, that $300 is divided between your student loans and all other nonpriority unsecured creditors including credit card debt and medical bills.
Rare exceptions. A few bankruptcy courts allow you to treat student loans differently, by
- paying student loans before you pay any money on other unsecured debt like credit cards and medical bills
- paying more towards student loans than is paid towards other unsecured creditors, or
- paying student loans outside of your Chapter 13 plan.
Paying Student Loans Through Your Chapter 13 Plan
Even if you cannot discharge student loans in bankruptcy, Chapter 13 can relieve your financial burden by allowing you to pay only what you can afford on your unsecured debts, including student loans. (To learn how this works, see The Chapter 13 Bankruptcy Repayment Plan.) In some cases though, Chapter 13 might increase your overall student loan debt when the bankruptcy is over.
When Chapter 13 can make a dent in your student loan debt. If you have very little or no other general unsecured debt (like credit card or medical debts) and you can make sizable plan payments, you may even be able to pay down, or pay off, your student loans in Chapter 13.
When Chapter 13 can increase the size of your student loan debt. If what you can afford is very little, or if you have a lot of credit card debt or medical bills that must share in the distribution, only a small portion of your Chapter 13 payment will go towards student loan creditors. In the meantime, interest continues to accrue. If your payment is not sufficient to cover the interest, student loan debt can actually grow while you are in bankruptcy.
When Chapter 13 helps even if you pay little towards student loans. But if you need the breathing room and can use the time you are in Chapter 13 to get on your feet and improve your financial situation (for example, by getting a better job or discharging other debt that is making it difficult to pay your student loans), it may still be worthwhile. You may be able to use this time to put yourself in a better position to pay the loan after the bankruptcy.
How to Maximize Your Payment on Student Loan Debts
There are some steps you can take to maximize the amount of your Chapter 13 payment that goes to pay your student loan debt.
File a Chapter 7 First to Get Rid of Your Other Unsecured Debt
If you qualify for Chapter 7 bankruptcy and you have a lot of other general unsecured debt that will end up diluting the payments you make on student loans in a Chapter 13, you might benefit from filing a Chapter 20 bankruptcy. This is where you file a Chapter 7 first, to get rid of your dischargeable debt and follow with a Chapter 13 to maximize payments on non-dischargeable debts while under the protection of the automatic stay.
You still won't be able to discharge student loans, but you will get time to pay them in the Chapter 13 and, with your credit cards and medical bills discharged in the Chapter 7, a greater portion of your Chapter 13 payment can go towards those student loans.
Pay Student Loans Outside the Chapter 13 Plan
A few bankruptcy courts allow you to treat student loans differently. Depending on where you file, the court may allow you to make your current student loan payments outside the plan, while making up any back payments in the bankruptcy. This is not the case in most districts.
However, you may be able to convince the court to allow different treatment for student loans if you have special circumstances. For example, if your income is important to make your Chapter 13 plan payment (which is true in most cases), and you risk suspension of your professional license if your student loans are delinquent (meaning you'd be unable to earn income), the court may consider different treatment.
After You Complete the Chapter 13 Plan
If your student loans are not paid in full during your Chapter 13, you will have to continue to make payments after bankruptcy. However, you may be able to work out a new payment plan with your student loan creditor as you approach the end of your Chapter 13. Some are willing to do this based on the fact that you made regular payments for several years in Chapter 13. Others may still require you to rehabilitate your loans first, but since your other unsecured debt will be discharged, you may have more income available to do that after the bankruptcy. (Learn how to rehabilitate your student loans.)