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Bankruptcy is not the answer…or is it?

When it comes to student loans, bankruptcy tends to be useless. But not always. Sometimes it can help. Sometimes it can hurt. Let’s take a deeper look.

Bankruptcy Helps

If you have a federal student loan with a wage garnishment or social security offset, a bankruptcy can offer protection. Once a bankruptcy is filed, wage garnishments and federal benefit offsets stop. Of course, if you don’t fix the default status by the completion of your bankruptcy, the garnishment or offset can start up again.

If you have a student loan in default, collection activity stops when you file a bankruptcy. This protection also extends to any co-signer (private student loans). No lawsuit can be started or continued either (though there are exceptions).

Bankruptcy Hurts

Many private student loan promissory notes contain a default provision should a bankruptcy be filed by either the signer or co-signer. It’s not uncommon for a co-signer to file bankruptcy, resulting in a default against the signer, even though the signer was making timely payments. There is a question of how legal this is, but as of yet, no case has come to a final determination. The answer may depend on location.

Bankruptcy is Useless

For the most part, student loans are non-dischargable except upon the showing of undue hardship. This is often a difficult thing to prove and can be costly. You shouldn’t fear this (see my other blog about this). While there are certain situations that are easy to demonstrate undue hardship, bankruptcy is often the more difficult path to discharge. I’m talking about people with total and permanent disability.

I’ve been to several student loan seminars where a creditor’s attorney (they represent the Department of Education or other industry participants) tells stories of a person who easily qualifies for undue hardship because of disability, but who didn’t know about the ADMINISTRATIVE process for discharge. Worse, these people are often represented by counsel. That means the lawyer didn’t know about it either.

Yes, there is an administrative discharge available for totally and permanently disabled borrowers. Just fill out some paperwork, send in supporting evidence, and 60 days later a decision is rendered. And it’s free (though you may want an attorney to help to make sure everything is in order). Compare that to the bankruptcy discharge process, which could take years and cost quite a bit. There is one small advantage to the bankruptcy discharge, however. The discharge is tax free, where as an administrative discharge here would be a taxable event. That might still be cheaper and quicker to deal with than the whole bankruptcy process.  Think about it.

Another example of where it is useless is when attempting to discharge a student loan because the payments seem unaffordable. You would not believe the creditor attorneys stories about Federal student loan borrowers who didn’t know about affordable payments based on income. And again, their attorney didn’t know either. Yes, it is possible to get affordable payments. They can be as low as ZERO dollars! Imagine trying to show a judge that you have a hardship when the attorney for the student loan shows the judge that you can have a small payment of $5 or $10 or ZERO dollars a month. Hear that? That’s the air leaving your balloon of a discharge case. (NOTE: I don’t buy this argument, BUT, you can’t fight it if you don’t know about it in the first place!)

Bankruptcy can also be useless if your attorney doesn’t really understand student loans. The examples above are just a few things some attorneys don’t know about. I’m not saying this is common among bankruptcy attorneys, but if I’m still hearing these stories and fielding these questions, it’s obvious that not enough bankruptcy attorneys realize all the things that can be done with student loans OUTSIDE of bankruptcy.

Bottom Line

There are many reasons people file bankruptcy. My point is, ask your bankruptcy attorney how filing will impact your student loans. Will it be helpful, hurtful, or useless?

 

Comments

  1. One thing bankruptcy does that you didn’t mention is to reduce the number of creditors competing for your income. Your budget may look different if you discharge credit card or medical debt.

    • Joshua Cohen

      Yes, Cathy, you are correct. And that can make a world of difference.

  2. While Chapter 13 may not be a solution per se, I think it’s difficult to overstate its value as a safe harbor for low-income private student loan borrowers. In many jurisdictions, these borrowers have the option of channeling most of a near nominal plan payment to their student loan creditors, paying next to nothing to their other creditors, avoiding garnishments and shutting down the collectors for five years.

  3. What is with the status of private loans in chapter 13 after the discharge. Are they treated with the same non-dischargeable status as federal loans?