Bankruptcy gives you tools to deal with special debts—including those you can’t easily write off. Last week we got into income taxes. Today we discuss student loans, focusing on this special kind of debt in Chapter 7 “straight bankruptcy.” Next week, we’ll cover student loans under Chapter 13 “adjustment of debts.”
Let’s assume you owe a student loan that you can’t afford to pay. Here’s how Chapter 7 can help.
Student Loan Collection
Student loan creditors and collectors have extraordinary collection powers. Often they don’t need to sue you first and get a legal judgment against you, as most creditors must. These creditors and their collectors have very aggressive collection procedures available to them. Besides the usual garnishment of bank accounts and paychecks, these special creditors can often grab your tax refund or a portion of a Social Security benefit check.
The “Automatic Stay” from a Chapter 7 Filing
Student loans are special in a number of ways. However, just like ordinary debts, student loan collections are immediately stopped by the “automatic stay” imposed by your bankruptcy filing. It doesn’t matter whether or not the student loan would be discharged (written off) in your Chapter 7 case.
The “automatic stay” stops “any act to collect, assess, or recover a claim against the debtor.” (Section 362(a)(6) of the U.S. Bankruptcy Code.) (A “claim” is a “right to payment”—essentially, a debt. See Section 101(5).) More specifically, the “automatic stay” stops “the commencement or continuation . . . of a[n] . . . administrative . . . proceeding against the debtor. (Section 362(a)(1).) “Administrative proceedings” include the non-judicial collection actions mentioned above that don’t include a lawsuit. The Chapter 7 filing also specifically stops “the setoff of any debt” owed to you, such as a tax refund or Social Security setoff. (Section 362(a)(7).) So, filing bankruptcy stops all student loan collection actions.
This break from collections lasts throughout the 3-4 months that most consumer Chapter 7 cases take to finish. But unless you deal with the student loan appropriately in the meantime, after that its collection can continue.
Dischargeability of Student Loans
Bankruptcy permanently discharges (legally writes off) some student loans. A dischargeable student loan must meet just one condition, albeit a tough and confusing condition. The student loan must cause you an “undue hardship.” As the Bankruptcy Code puts it, you can’t discharge a student loan unless that loan “would impose an undue hardship on the debtor and the debtor’s dependents.” (Section 523(a)(8).)
What does “undue hardship” mean? How much harder must it be than just a simple “hardship”?
You may feel like your student loans are causing you a great financial hardship. However, the federal courts have interpreted this phrase very narrowly. The details are beyond the scope of today’s blog post, but just keep in mind this condition is quite challenging to meet.
During the Chapter 7 Break in Collections
During the 3-4 months of your Chapter 7 case you want to take steps to make the temporary break in collections a permanent one. Here are three ways to accomplish this.
- If you and your bankruptcy lawyer believe you meet the “undue hardship” condition, your lawyer would file an “adversary proceeding” during your Chapter 7 case. That’s a specialized lawsuit designed to determine whether you qualify for “undue hardship.” If you persuade the bankruptcy judge that you do, the student loan debt would be permanently discharged. Then the temporary break in collections would become permanent. There would be no more collection on a debt once you no longer legally owe it.
- The bankruptcy judge may give you only a partial discharge of your student loan(s). In this situation the judge is determining that repaying all of the loan(s) would cause you an “undue hardship.” But paying back only a portion would not. So you’d make arrangements to pay the remaining student loan debt, probably at a reduced monthly payment. As long as you made the payments your student loan creditor would take no further collection action against you.
- If you don’t qualify for a full or partial “undue hardship” discharge, your Chapter 7 case would still at least discharge all or most of your other debts. That should leave you better able to pay the remaining student loans. Hopefully you’d be in a position to make payment arrangements. This may be done through a payment-reduction program which are available for various student loans. If so, then your situation would hopefully be resolved by the end of your Chapter 7 case. Then, at the time that the automatic stay would expire you won’t be facing any more student loan collections.
Avoiding Default and Preserving Options
Even if you don’t qualify for “undue hardship,” the bankruptcy pause in collections can be extremely helpful. It could maybe even be critical. That’s because you can only qualify for most student loan workout programs before you are too far behind on payments. So filing a Chapter 7 case before you’ve fallen too far behind could allow you to take advantage of these programs. But if you waited too long you could lose out, and be seriously disadvantaged.
It’s really crucial to talk with an experienced Louisville bankruptcy lawyer about all this. Student loans are complicated and often very challenging to deal with. This is true both outside and inside bankruptcy. You need a lawyer on your side who deeply understands both bankruptcy law and student loans.