Which Chapter to Choose for Your Student Loans When Filing for Bankruptcy?

Posted by Danny Smith December 1, 2024

Filing for bankruptcy is a challenging decision that comes with significant financial and emotional implications. While it can provide relief for overwhelming debt, addressing student loan debt through bankruptcy involves unique challenges. Below, we break down the process, types of bankruptcy, and important considerations to guide you through this complex journey.

Understanding Bankruptcy and Student Loans

Bankruptcy offers a legal pathway to manage debts when financial obligations become unmanageable. However, it’s crucial to recognize that discharging student loans through bankruptcy is exceptionally difficult and often partial, if successful at all. Additionally, filing for bankruptcy can negatively affect your financial future, including your credit score and ability to secure loans.

Types of Bankruptcy: Chapter 7 vs. Chapter 13

Bankruptcy for individuals is generally filed under Chapter 7 or Chapter 13. Each has distinct processes and outcomes depending on your financial situation and eligibility.

Chapter 7 Bankruptcy

Chapter 7, often called “liquidation bankruptcy,” involves selling non-exempt assets to pay creditors. Here’s how it works:

  • Eligibility: To qualify, your income must be below your state’s median income, and you must pass a means test. Additionally, you cannot have filed for Chapter 7 bankruptcy in the past eight years.
  • Process: A court-appointed trustee will evaluate your assets, liquidate those deemed non-exempt, and distribute the proceeds to creditors. Remaining eligible debts, including some student loans, may then be discharged.

While Chapter 7 provides swift debt relief, it is not always accessible for individuals with higher incomes or substantial assets.

Chapter 13 Bankruptcy

For those who don’t qualify for Chapter 7, Chapter 13 bankruptcy offers an alternative. This option is often referred to as “reorganization bankruptcy.”

  • Eligibility: Chapter 13 is ideal for individuals who fail the means test but still need debt relief while retaining key assets, such as a home.
  • Process: Under Chapter 13, a trustee develops a repayment plan spanning three to five years. You are required to use your disposable income to repay debts, including student loans, during this period. The court oversees the repayment plan to ensure compliance.

Chapter 13 allows debtors to keep their property, but the extended repayment timeline can be demanding.

Challenges in Addressing Student Loan Debt

Unlike most debts, student loans are notoriously difficult to discharge through bankruptcy. Courts require borrowers to prove “undue hardship,” which can be challenging to demonstrate. Here are some key points to consider:

  • Priority of Payments: If you have multiple debts, the court prioritizes repayment based on the type of debt. Student loans often take a backseat to higher-priority obligations, leading to prolonged interest accrual.
  • Federal Loans: Discharging federal student loans through bankruptcy is nearly impossible, as alternative government repayment programs are available. Borrowers must explore these options before considering bankruptcy.

Costs and Additional Considerations

Filing for bankruptcy involves costs, including court filing fees and attorney fees, which can be waived in certain circumstances for low-income individuals. Additionally, while bankruptcy can provide relief from unmanageable debts, the long-term consequences—such as a damaged credit score—should be carefully evaluated.

Conclusion3

While bankruptcy can offer a fresh financial start, it is not a guaranteed solution for student loan debt. Before initiating the process, consider consulting a bankruptcy attorney or financial advisor to explore all available options and understand the implications. The decision to file should be made with a clear understanding of the challenges and responsibilities involved.

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