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Paying back a student loan isn't optional

Erica Sandberg

October 21, 2014

QHi Erica,

I am 25 and in financial trouble, even though I should be in the best position, — at least that was my plan.

I did everything right. I went to college. My B.A. in business administration cost me $90,000 in Sallie Mae direct school loans. Then, I went to grad school to get my master's in marketing. Add $80,000 in private loans to that and my total school debt is $170,000 and counting because the interest is being added in. I also took out credit card loans while I was in grad school and to date owe $10,000 to Wells Fargo. I am at my limit, so I can't charge more.

I am now employed by a big firm in Boston with what they say is potential for career growth. My starting salary is $72,000, and that seems high, but that boils down to just over $4,000 a month after deductions and my 401(k). After paying all my bills, I have almost nothing left over for my debt.

How does this make sense? I feel like I did everything right in life, and I am no better off than I was when I first started college. I want to get rid of this debt. Can I just file for bankruptcy? –Elijah

ADear Elijah,

Oh, boy. I suppose it is up to me to tell you that you did not, in fact, do everything right. As much as I believe that a college education is a worthy endeavor, you over-borrowed for it. What did you think was going to happen after you graduated and the loans came due? The bank didn't gift you the money; they lent it. Now you're going to have to find a way to pay it back.

In general, student loans are not eligible for bankruptcy relief. For student loans to be eligible, you have to prove that paying them would make you destitute now and in the future, and that you've made every effort to repay.Ask Erica

Chapter 7 bankruptcy, a formal discharge of allowable debts, is an option for people who truly have no way of repaying their financial obligations. Though it is evident that money is tight, this method is an unlikely resolution for you.

Because your salary is greater than your state's median income of $55,794, you would have to pass the means test to qualify to file. This formula assesses your income and expenses, and if it appears that you have enough left over after meeting your essentials to pay at least a portion of your liabilities, you'll be denied the Chapter 7. The only type of bankruptcy available to you, then, would be a Chapter 13, which is a court-supervised, three- to five-year repayment plan (with possible discharge for allowable debts.)

So is 13 your lucky number? Again, I don't think so. The bulk of your balance is non-dischargeable student loans, and the standard repayment term for those is usually 10 years. If you were to include them in the bankruptcy, which you can't anyway, the payments that you're already struggling with would greatly increase. The debt that you owe to the credit card company may be forgiven, but it would not be enough to offset the higher loan payments.

Therefore, Chapters 7 and 13 bankruptcy are out, so this is what I think you ought to do:

  1. Direct student loans. Ask for an alternate repayment plan. Presuming your loans are in positive standing, you may be able to arrange for reduced payments that are based on your cash flow.
  2. Private loans. These types of loans don't come with as many flexible payment options as the direct loans, but lenders certainly want you to keep them out of default. Ask if they can arrange an extended payment plan. They may not, but it's worth a try.
  3. 401(k). Of course, preparing for your retirement is important, and by adding to your plan you're decreasing your tax liability. However, you're in the hole and need to climb out. Suspend contributions until you're in a better position, and apply the funds to debt. Because of your young age, time is on your side.
  4. Credit card. Chances are good that the interest rate on your card is much higher than what is on your student loans, so it should get the maximum of what you can afford until it's deleted. Determine the amount you have for total loan repayment. Subtract your necessary bills from what you bring in monthly (increased by the amount you were contributing to the 401(k) plan). Send most of that figure to Wells Fargo while also keeping your students loans in positive standing.

Here are some example numbers for inspiration:

+ $4,500 net income

–    $2,500 basic bills

–    $357 for the credit card (three-year repayment plan)

–    $660 direct student loans (20-year, extended repayment plan)

–    $848 private student loans  (10-year standard repayment plan)

= $135 left over for savings

Admittedly, this is a slim budget with little wiggle room. But if you really do move up the corporate ladder and your paycheck increases, you can beef up your expenses while still satisfying your creditors. In fact, the more you make, the more you should send until you are at a zero balance. Keep the faith!

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