STUDENT LOANS IN CHAPTER 13

STUDENT LOANS IN CHAPTER 13 – A PRIMER


Assuming you do not qualify for a hardship discharge (either offered by the government or through a Chapter 7), Chapter 13 can be a successful strategy for dealing with this type of debt. Often, when explaining the role of Chapter 13 in student loan management, potential clients seem confused and say 'I didn't think you could put student loans in bankruptcy'. The answer is complicated, and depends what is meant by 'putting' student loans 'in bankruptcy'. In Chapter 13, you can certainly do the following:

1. Stop student loan collections efforts.
   
2. Repay the student loans through your bankruptcy, and sometimes pay as little as 0%.
   
3. Pay the student loans separately from the bankruptcy if you desire.
   
   
   

While you can treat the student loans in the payment plan, they are typically non-dischargable, meaning when you're out of the case, to the extent you didn't pay any of the principal, they'll be back around when you're out. . But there are different reasons/methods for treating student loans. Let's look at a few.


THE LOW INCOME FILER


Many clients with student loans have issues paying what the creditor would like you to pay. Even in an income contingent plan, the hard realities of life, like raising children, or cost of living increases, can get in the way. Chapter 13 can make sense because in those cases, you can pay as little as 0% back to creditors while you're in the case. This has bad and good consequences. The bad is that unlike most other types of unsecured debts like credit cards or medical bills, the student loan debt continues to accrue interest. That means, assuming you don't pay anything towards your student loans while in the case, you'll actually owe MORE when you're out of the case in 3 to 5 years. While this is of little consequence if there's little to no chance you'll be paying them off in your lifetime due to age or illness, for the young filer, it could make things worse in the future. A smart move in some of those cases, where the student loans make up the bulk of your creditor claims, is to pay extra into your case to prevent 'negative amortization', which is a fancy way of saying it will prevent your loan from growing while you're in the case.


THE HIGH INCOME FILER


Some clients have so much income that they can pay a high percentage of their debt off in the Chapter 13. Where they have a large portion of their debt as student loan debt, it actually makes sense to pay this high amount in because it will tackle the debt and prevent it from growing. Additionally, the student loans are paid at the expense of the other creditors so a certain extent. For example, if you owe $100,000 in student loans, and $100,000 in credit card debt, and you are in an 80% plan, you'll wind up paying $80,000 to your student loans, and $80,000 to your credit card creditors. If you did not have student loans, you'd almost certainly wind up paying $100,000 to your credit card creditors, so having them in the case pulls money that would go to them and sends it to a debt that is non-dischargable.


THE 100% TO CREDITORS FILER (aka the VERY high income filer)


In this case, while student loan interest continues to accrue, often unsecured creditors interest rates are set either at zero, or close to zero (perhaps 3%), which is often more advantageous than prior to filing. But oftentimes Debtors in these plans want to pay their student loan debt outside of the plan. This usually does not make sense. Here's why. If your ability to make payments in the plan goes down, the student loans receive a share and can reduce the amount paid to credit card and medical bill debt. Further, where interest rates for student loans exceed or beat investment averages (i.e. 8%), paying these down makes good financial sense. That being said, you may want to talk to a financial advisor to be certain as to whether the time is right to pay them off.


ALTERNATIVE PLAN STRUCTURES

• One way to combat the issue of having a large student loan debt in higher income cases is to treat the student loan creditor as a 'special unsecured' creditor. In that situation, student loans are treated as a 'priority' and paid at the complete expense of your other unsecured debt, like credit cards and medical bills.
  
• Assuming you're a high income earner who must pay 100% to creditors, you may not WANT that large of a plan payment. Perhaps you want to invest your money in something that pays better returns than the interest rates on your student loan. In that case, you can pay 100% to your credit card and medical bill creditors, and remove the student loan from the case, paying it off over a longer period of time with an agreement made with the student loan company. I usually do not advise doing this, but this is something which should be viewed on a case by case basis.
  
• Another idea is that if student loan repayment through bankruptcy leaves you with more disposable income, you may want to plan to file Chapter 13 cases end-to-end. For example, two 5 year plans back to back to keep your head above water. Not everyone likes the idea of being 'in bankruptcy' for longer than 3 to 5 years, but in certain limited cases it makes sense, especially when creditors are ready to pounce once you exit your first case.
  
• There is the 'kick-the-can-down-the-road' Chapter 13, where you actually plan to pay 0% to your student loan despite the fact that it will keep growing. For example, if you're in your 40s, you're earning $35,000 a year with little chance of an increase and your student loans are $200,000 or more, the possibility that you'll pay these off is remote. In that case, you may want to file bankruptcy with the knowledge that you have no intention of paying the loans, but just want to survive. Courts are increasingly (though not overwhelmingly) discharging student loans in some of these cases in Chapter 7, but usually those cases involve mimimum wage employment and no ability to pay anything to those creditors.