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Bankruptcy and Student Loans


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TERMINOLOGY

Unlike most types of debt incurred by consumers, student loans cannot be forgiven by declaring bankruptcy. This is because student loans are considered "non-dischargeable" debt, which means that the debt stands even after bankruptcy and must be repaid by the consumer in the future.

There is, however, an exception to this rule. A consumer may have their student loans eliminated through bankruptcy if they are able to demonstrate that the loans create an undue hardship on the consumer or their family. 

In order for the undue hardship exception to be applied to a bankruptcy case, the filing consumer must first file a separate motion in bankruptcy court and then schedule a meeting with the presiding judge to explain the specific circumstances of the undue hardship.  Three things must clearly be demonstrated during this meeting for the standard of undue hardship to be met:

1. That the consumer has made a good faith effort to repay the loan.

2. That the consumer's financial difficulties are likely to continue or deteriorate.

3. That the consumer cannot simultaneously maintain a minimum standard of living and repay the loan.

It is important to note that most judges will not consider the standard of undue hardship to have been met if the consumer is physically able to work and if their financial situation is not likely to improve in the near term.  Legal experts therefore advise those whose debts are primarily comprised of student loans to avoid bankruptcy unless they are disabled.  It is the exception (not the rule) that bankruptcy courts actually forgive student loans.

Until recently, student loans from private lenders were able to be discharged under Chapter 7 bankruptcy.  This changed in 2005 with the Bankruptcy Abuse Prevention and Consumer Protection Act which categorically states that any education loan that may be considered a tax deduction is not eligible to be discharged. 

Consumers carrying student loan debt should be also be aware that consolidation with other bills is possible under a Chapter 13 filing.  There are a few stipulations in consolidating this type of debt, among them a carefully worked out plan dictating how the consumer plans to repay their debt over a period of three to five years.  

Consumers may also challenge their total loan balance that may have become inflated as a result of being transferred through several lenders.  If a consumer successfully challenges the balance in a Chapter 13 filing, the final decision on what the consumer owes is binding and must be adhered to even if the loan's repayment period extends beyond the duration of the bankruptcy plan.

There are other alternatives that consumers may consider depending upon the default status of their loans.  Consumers may try to convince the lender to postpone repayment until an individual's financial situation improves.  They may also establish a  plan with the lender that allows them to repay the loan over a longer period of time.  Some may also be able to consolidate all their student loans into one loan at a lower interest rate that allows the consumer more time for repayment.