But for a showing of undue hardship, student loans are non-dischargeable in bankruptcy; outside of bankruptcy, there are few options for a struggling debtor to find relief from crushing student loan debt. Moreover, student loan debt has no special status in bankruptcy; you cannot “just choose” to pay your student loans ahead of other unsecured debt (e.g. credit cards).
So, what is a struggling debtor to do? Chapter 13 bankruptcy may provide relief to a the student loan debtor under certain circumstances: the chapter 13 can stop collection and garnishment activity, and eliminate other debt problems such as credit card debts and stop a foreclosure; but the debtor will usually emerge from chapter 13 bankruptcy still needing to pay on student loans. The problem is that during the 3-5 years of the chapter 13 plan, if no payment is made toward the student loans, the balance is significantly higher after bankruptcy; which is not an ideal result. So, how can you pay student loans in chapter 13 bankruptcy?
There are 3 approaches to paying student loans.
1. Reclassify Tactic: Using bankruptcy code section 1322(b)(1), classify student loans differently than other unsecured creditors and budget the student loan payment. Chapter 13 bankruptcy allows you to classify creditors and then pay according to that classification. The main rule under this tactic is that the proposed student loan payment cannot unfairly discriminate against other unsecured creditors. Also, when you classify a creditor differently, you need a basis to do so; the mere fact that student loans are non-dischargeable is usually insufficient to reclassify student loan claims, you need some other factor.
So, under the reclassify tactic, there are two scenarios that are usually approved. First, if your other unsecured creditors (e.g. credit cards) will receive 100% of their allowed claims, most courts will allow payment of student loans. Second, if your chapter 13 means test shows that your unsecured creditors would not receive a dividend, then it may be possible to pay student loans. However, that second scenario is rare, if the chapter 13 means test shows no disposable income, it begs the question as to why you are in chapter 13 bankruptcy. In any event, in both cases the unsecured creditors are not being unfairly discriminated against; in the first scenario, the other unsecured creditors are being paid in full, and under the second scenario, based on the rules of chapter 13 bankruptcy, the other unsecured creditors would receive no money anyway. Beyond those two scenario’s, the cases get fact specific; for example, if the debtor would lose a professional license upon a student loan default, that can serve as a basis for reclassifying and paying student loans; the argument being that if the debtor loses his license, he won’t be able to fund any plan.
2. Cure and Pay Tactic: Using bankruptcy code 1322(b)(5) to cure a default on student loan payments and maintain periodic payments. You would think this provision would be the default way of handling student loans; the language seems clear and obvious:
(5) notwithstanding paragraph (2) of this subsection, provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment is due after the date on which the final payment under the plan is due;
Essentially, if the remaining term of the student loan would exceed the length of the chapter 13 plan, and the debtor is in default, this code section clearly implies that the debtor may cure the default and continue to make payments. But not unsurprisingly, many courts disagree and still require that the debtor show that payments to student loans would not unfairly discriminate against other unsecured creditors. So, if you can pay $600 to your student loans, and your other unsecured creditors will only receive $10 per month, many courts see that as a problem. Basically, the courts are split on this tactic, as they are split on the reclassify tactic, but the cure and pay tactic is an option.
3. The Practical Tactic: Simply pay your student loans with money you save during the chapter 13 plan. The key to chapter 13 success comes down to your budget and your attorney’s aggressiveness on getting you a reasonable budget. A good chapter 13 bankruptcy attorney will always push the envelope. But the flip side is that once the budget is established, the debtor must have spending discipline. Chapter 13 plans are not designed to be sparse, but if the debtor really wants to succeed, some lifestyle changes are a good idea. For example, if your budget allows $800 per month for food, nowhere in the chapter 13 plan does it require the debtor to spend $800 per month on food. A good attorney aids a client in establishing the debtor’s budget to provide breathing room in certain budget categories. However, the debtor needs to have discipline not to spend the full amount, save the difference, and apply it to student loan payments.
Note, this tactic is not written into the chapter 13 play, this tactic is not about officially paying your student loans outside of bankruptcy; this tactic is merely the debtor being practical and reasonable in dealing with student loan debt and not allowing that debt to balloon during a chapter 13 bankruptcy.
Finally, if you do none of the above, your student loans get lumped in with your other unsecured creditors, so the student loans will receive their prorated distribution, however, that amount is usually not enough to keep the student loan balance from growing during the chapter 13.
Chapter 13 bankruptcy does provide some relief for student loan debt; and really, it is the only bankruptcy chapter that at least provides some option for dealing with student loans. Ideally, I would like to see legislative change in lines with my article, Making Student Loans a Priority, but until that time, the tactics listed above are the best bankruptcy options for student loans. You will want to find an attorney that is familiar with the issues and willing to do the research and work to get you the best possible result.
