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Filing for Chapter 13 bankruptcy can provide a structured path to manage overwhelming debts, but it's important to understand how this process affects student loans.
While Chapter 13 offers relief, it doesn't automatically discharge student loan debt. Here's what you need to know.
Chapter 13 bankruptcy allows individuals with regular income to propose a repayment plan to creditors, which typically lasts three to five years.
During this period, debtors make monthly payments to a bankruptcy trustee, who then distributes the funds to creditors. This process provides a way to catch up on overdue debts and reorganize financial obligations.
Student loans are generally considered non-dischargeable debts in bankruptcy. This means that, in most cases, filing for bankruptcy does not eliminate student loan obligations. However, Chapter 13 bankruptcy can still impact how these loans are managed.
How Chapter 13 affects student loan payments
While student loans aren't discharged through Chapter 13, the bankruptcy process can influence repayment . Student loans are treated as nonpriority unsecured debts, similar to credit card debt or medical bills.
This classification means they receive a pro-rata share of the total amount paid to unsecured creditors in the repayment plan. The specific amount allocated depends on the debtor's disposable income after ing for necessary living expenses.
Additionally, the automatic stay provision in Chapter 13 halts collection actions from creditors, including student loan servicers, for the duration of the bankruptcy case. This pause can provide temporary relief from collection efforts and prevent wage garnishments or other aggressive tactics.
The challenge of discharging student loans
Discharging student loans in bankruptcy is possible but challenging. To achieve this, debtors must file an adversary proceeding-a separate lawsuit within the bankruptcy case-demonstrating that repaying the loans would cause "undue hardship."
This legal standard is difficult to meet and requires proving:
- The debtor cannot maintain a minimal standard of living if forced to repay the loans.
- The financial hardship will persist for a significant portion of the repayment period.
- The debtor has made a good faith effort to repay the loans.
Courts apply these criteria strictly, and only a small percentage of cases result in student loan discharge. Therefore, most individuals will remain responsible for their student loans even after completing a Chapter 13 bankruptcy plan.
It's important to note that filing for Chapter 13 bankruptcy does not relieve cosigners of their responsibility for the debt.
Cosigners remain liable for the student loan, and creditors can pursue them for repayment. This aspect underscores the need for cosigners to be aware of the borrower's bankruptcy proceedings and the potential implications for their financial obligations.
Recent developments: Credit toward loan forgiveness
Recent changes in federal regulations have introduced provisions that may benefit individuals with federal student loans undergoing Chapter 13 bankruptcy.
Starting July 1, 2024, debtors in Chapter 13 can receive credit toward Public Service Loan Forgiveness (PSLF) and Income-Driven Repayment (IDR) forgiveness programs for each month they make required payments under their confirmed Chapter 13 plan.
This credit applies even if the debtor is not making direct payments on their student loans during the bankruptcy period. To ensure proper credit, it's advisable for debtors to include a plan provision requiring compliance with this new regulation and to the credit with their loan servicer upon case closure.