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Sorry, bankruptcy rarely wipes out student loan debt

Erica Sandberg

August 28, 2015

QHi Erica,

I am thinking of doing Chapter 7 bankruptcy and wondering why some things can be included and other things cannot. I have $80,000 in student loans (deferred so far) and almost $20,000 in combo credit cards and collection debt. I'm not working now. If I go through with this, I can get rid of the combo debt but not my biggest, my student loan. Why? Does is make any sense for me then? —Pat

ADear Pat,

The bankruptcy you mention allows qualified individuals to discharge many types of financial obligations. That's pretty amazing, because once they're forgiven, you never have to worry about them again. As noted, that includes balances you owe to credit card companies and collection agencies that have purchased unpaid accounts. Other debts you may include are:
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  • medical bills
  • past-due utility bills and back rent payments
  • post-repossession deficiency balances
  • monetary judgments (if you were sued for a debt and lost the case)
  • unpaid taxes older than a certain number of years
  • many attorney fees

And while that's a decent list, you'd be stuck not only with the student loans, but others you may have, such as:

  • recent taxes
  • spousal and child support arrearage
  • what you might owe after committing a crime (including DUIs and restitution owed to victims)
  • legal fines, such as parking tickets
  • homeowners' association dues

Without knowing the details of your personal finance situation, it's impossible for me to know if Chapter 7 is a sensible decision for you. However, before filing, you'll have to go through a bankruptcy education and counseling course and that will provide you with invaluable insight. The program is divided into two parts — the first is before filing, so you understand eligibility requirements as well as its pros and cons, The other happens afterwards, and its purpose is to reduce the chance you'll ever have to visit bankruptcy court again.

As for why student loans are almost always exempt from a bankruptcy discharge, I spoke with Mark Kantrowitz, senior vice president of edvisors.com, a student loan information company, for some background. “Student loans were dischargeable up until the 1970s,” says Kantrowitz. “However, there were some anecdotal arguments that borrowers were graduating from college, not getting a job and then filing bankruptcy on their loans. They were manipulating the system.” For that reason, he says, Congress clamped down. First they made federal loans non-dischargeable, then private student loans slipped in under those restrictions. However, you can ask a bankruptcy attorney to see if you could file an “adversary proceeding” in which you would have to prove that repaying the student debt would cause “undue hardship.” It's worth a shot, but don't get your hopes up.

To your question about whether it could make sense to discharge the smaller debt while being left with those far larger, consider how much money you'd be left with by doing so. Without the payments going toward the eliminated liabilities, you can apply them to what you are left with: your student loans.

And if you still don't have the extra money to pay your student loans when they come due? Keep them in good standing and you have some good options. You may request another deferrence. Interest won't collect on the subsidized portion and you'll have time to find a good job. If you're denied a deferrment, try for a forbearance. Though interest on all portions of the loan will accrue, you'll still buy time to seek employment.

In the event you do start working, but can't cover the payments on the typical 10-year repayment term, apply for one of the flexible payment arrangements. For example, an income-sensitive plan will be based on your pay and expenses. Just keep the loans out of default. If you don't, the repercussions can be severe. The holder can garnish your wages without having to sue you and win a judgment, and intercept tax refunds, huge fees will pile up and collectors will call (and call and call).