Navigating Chapter 13 Bankruptcy and Student Loan Debt

The United States Bankruptcy Code offers a path to financial recovery for those burdened by debt. This is especially crucial for consumers struggling with long-standing student loan debt, some of whom may have encountered unfair lending practices. While a common misconception persists that student loans are never dischargeable in bankruptcy, this is untrue. Student loans can be discharged in bankruptcy, although the process can be challenging.

Understanding Student Loan Discharge in Bankruptcy

The perception that student loans are impossible to discharge stems from the fact that it's more difficult compared to other unsecured debts. The Bankruptcy Code mandates a stricter test - demonstrating "undue hardship" - and an additional legal step known as an "adversary proceeding," which is essentially a lawsuit within the bankruptcy case. Despite these hurdles, discharge remains a possibility for borrowers.

Importantly, certain loans that borrowers may consider “private student loans” are not subject to that standard and extra step. Instead, some private loans for educational purposes can be discharged in a normal bankruptcy proceeding, just like most other consumer debts.

Types of Education Loans That May Be Dischargeable

Several types of loans related to educational expenses can be discharged in bankruptcy like other unsecured consumer debts, without needing to meet the "undue hardship" standard or undergo an adversary proceeding. These include:

Loans exceeding the cost of attendance: This can occur when the loan amount surpasses expenses like tuition, books, room, and board, and is paid directly to the borrower.
Loans for ineligible institutions: Loans used for education at institutions lacking Title IV funding, such as unaccredited colleges, schools in foreign countries, or unaccredited training and trade certificate programs.
Loans for professional exam expenses: Loans covering fees and living expenses incurred while studying for professional exams like the bar exam.
Loans for residency expenses: Loans that cover fees, living expenses, and moving costs associated with medical or dental residencies.
Loans for less than half-time students: Loans provided to students attending school on a less than half-time basis.

Troubling Reports of Industry Practices

Despite the availability of bankruptcy protections, the CFPB has documented that student loan borrowers rely on their servicers to provide timely and accurate information about their loans, including the protections the law provides when borrowers have trouble paying their loans. Regrettably, complaints submitted to the CFPB suggest that some of these companies might be making false statements to borrowers about the protections bankruptcy offers-or worse, even collecting on debts that have already been discharged by a bankruptcy judge.

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Consumer complaints raise serious questions about whether student loan companies are violating discharge orders-meaning they’re unlawfully collecting on loans even after a borrower has been through bankruptcy.

One consumer shared:

I have argued numerous times that [Direct to Consumer XYZ] loan was discharged as part of my … chapter 7 bankruptcy (see attached). They have collected monthly payments since then as part of the “charge off,” they have been reporting my account as late each month since then to the various credit agencies even though I’ve been paying their “agreed upon” monthly payments. As per a number of recent cases, it has been determined that in fact the [Direct to Consumer XYZ] loans were dischargeable.

Another consumer wrote:

There are two student loans that I took out with [Bank] while I was in college from 2006 to 2010. . . . The [Bank] student loans were discharged in Bankruptcy …. I have attached the discharge papers and highlighted the two [other Company] loans as well as the courts sentence stating that the unpaid amounts have been discharged. These are non-qualified private student loans, so they are not exempt from discharge under the bankruptcy code. They were taken out as direct consumer student loans, not certified by the school, and they were in excess of my scholarship and the federal student loans that covered by tuition. No further petition needs to be filed with the court for the discharge, according to the bankruptcy code any non-qualified private student loans are automatically discharged. I've told [other Company] this multiple times, but they just say that student loans can't be discharged in bankruptcy, which is only accurate for federal and private qualified student loans.

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Another consumer wrote:

I filed for a chapter 7 which was [discharged] satisfactory …. My chapter 13 was [discharged] satisfactory this year …. I had a [Direct to Consumer XYZ] loan in 2007 which has been in derogatory status for a few months prior to my chapter 13 filing. . . . [S]omething told me to research the loan that I had. I took out what was called “[Direct to Consumer ABC] loan” which is considered a non traditional student loan. This was a loan they offered for students only which was sent directly to the student to do basically whatever they wanted. Which I took advantage of to help with bills and whatnot as being a young single parent full time student part time job.

After doing my research, I found out on several different platforms from back google searches that [Direct to Consumer XYZ] loans are NOT student loans and are FULLY discharged debts in bankruptcy. My immediate thought is that this should have been resolved when my chapter 7 was completed. They were included in my chapter 13 and received a payment. Now that my chapter 13 is complete, they have went back to reporting my account as derogatory, charged off and my account is still headed for collections. I have provided them the info, and they refuse to budge.

Student loan companies cannot collect debts that a consumer no longer owes. As noted above, certain types of education loans are dischargeable in bankruptcy without the higher standard and without the filing of an adversary proceeding. Collecting on debts that have been discharged through bankruptcy might not only violate the Consumer Financial Protection Act’s prohibition on unfair, deceptive, and abusive practices-it could also violate the order of a United States bankruptcy judge.

These complaints raise serious concerns about the practices of private student loan owners, lenders, servicers, and collectors and their handling of bankruptcy discharges.

Read also: Bankruptcy and Student Loan Debt

Has Your Loan Been Discharged? Key Questions to Ask

If you've undergone bankruptcy and are still facing collection efforts on private student loan debt, consider these questions:

Was the loan amount solely for the cost of attendance (tuition, books, room, and board), or did it exceed those expenses?
Did the loan finance education at an unaccredited institution, a foreign school, or an unaccredited training program?
Did the loan cover fees or expenses related to professional exams, board examinations, or medical/dental residency costs?
Were you enrolled less than half-time when you took out the loan?

If the answer to any of these questions is yes, your loan might have been discharged.

The Brunner Test: Proving Undue Hardship

Most court cases cite Brunner v. New York State Higher Education Services Corp. for a definition of “undue hardship”. Brunner v. NY HESC (In re Brunner), 831 F.2d 395 (2d Cir. 1987), aff’g 46 B.R. 752 (Bankr. S.D.N.Y. 1985). That decision adopted the following three-part standard for undue hardship:

Inability to Maintain a Minimal Standard of Living: The debtor cannot both repay the student loan and maintain a minimal standard of living based on current income and expenses.
Persistence of Hardship: This situation is likely to persist for a significant portion of the repayment period of the student loans.
Good Faith Effort to Repay: The debtor has made good faith efforts to repay the loans.

The first element usually involves the lowest monthly payment available to the borrower, namely the monthly loan payment under Income Contingent Repayment, as opposed to standard ten-year repayment. The poverty line is often used as a threshold for a minimal standard of living, since it is defined as the income level at which the family has no discretion concerning how to use the income. However, the courts will generally examine all of the debtor’s expenses to ensure that they are minimal and necessary.

The second element requires the debtor to provide evidence of additional exceptional circumstances that are strongly suggestive of a continuing insurmountable inability to repay, such as being disabled or having a disabled dependent. There must be a “certainty of hopelessness”, meaning that there is no chance of any future improvement in the borrower’s financial situation.

The third element requires the borrower to have demonstrated a good faith effort to repay the loans. Filing for a bankruptcy discharge immediately after graduation is generally not considered a good faith effort to repay the loans. The court will consider whether the debtor made payments on the loans when he or she had some income available and obtained a deferment or forbearance when his or her income was insufficient.

Chapter 13 Bankruptcy: An Alternative Approach

Even if a full discharge isn't possible, Chapter 13 bankruptcy can provide a structured framework for managing student loan debt alongside other obligations.

How Chapter 13 Works With Student Loans

In Chapter 13 bankruptcy, student loans are treated as nonpriority unsecured debts, similar to credit cards and medical bills. While the student loan itself might not be discharged, Chapter 13 can offer several benefits:

Automatic Stay: This immediately halts collection efforts, providing temporary relief from aggressive lenders.
Structured Repayment Plan: A Chapter 13 plan allows you to make affordable monthly payments to a bankruptcy trustee over a period of 3-5 years. This plan can include student loan payments, potentially reducing the overall financial pressure.
Potential for Reduced Payments: The plan is based on your disposable income, meaning you only pay what you can afford. In some cases, this might result in lower monthly payments towards your student loans.
Debt Management: Chapter 13 can help you manage your overall debt burden, making it easier to address student loans after the bankruptcy period.

Important Considerations for Chapter 13

Interest Accrual: Interest continues to accrue on student loans during Chapter 13, potentially increasing the total debt.
No Automatic Discharge: Completing a Chapter 13 plan does not automatically discharge student loans. You'll still be responsible for the remaining balance.
Impact on Forgiveness Programs: Filing for Chapter 13 might extend the time required to qualify for student loan forgiveness programs.

Chapter 13 and Student Loan Forgiveness

Income-Driven Repayment (IDR) Forgiveness: For federal student loans, months spent in Chapter 13 can count toward income-driven repayment forgiveness if the required plan payments are made. This eligibility is tied to Chapter 13 plan payments, not direct loan payments.
Public Service Loan Forgiveness (PSLF): Time spent in Chapter 13 does not automatically count toward Public Service Loan Forgiveness. PSLF has separate requirements, generally involving qualifying payments made under specific repayment conditions while working for an eligible employer.

Navigating Chapter 13 After Completion

Once the Chapter 13 plan is complete, several options exist:

New Payment Plan: Work with your lender to establish a new payment plan based on the remaining student loan balance.
Modify Chapter 13 Plan: Consult with your Chapter 13 bankruptcy attorney to determine whether it may be a good idea to modify your Chapter 13 payment structure.
Dismiss your Chapter 13 case: A new student loan payment plan may mean that you don’t need a Chapter 13 bankruptcy at all, which can be beneficial to you in the long run. Although filing for bankruptcy isn’t the right choice for everyone and it’s extremely rare for student loan debt to be discharged, it can be an effective way to make your student loan payments more manageable.

Bankruptcy and Eligibility for Financial Aid

Will a bankruptcy affect a student’s future eligibility for student loans and other financial aid?

Generally speaking, a bankruptcy should have no impact on eligibility for federal student aid. As long as there are no delinquencies or defaults on student loans currently in repayment, the student should be eligible for additional federal student loans, regardless of any past bankruptcies. However, if some of the student’s federal student loans are in default and were not included in a bankruptcy, the student will not be able to get further federal student aid until he resolves the problem. Parents who apply for a PLUS loan (or graduate students applying for a Grad PLUS loan) may be denied a PLUS loan if they have an adverse credit history. The definition of an adverse credit history includes having had debts discharged in bankruptcy within the past five years.

Private loans are an entirely different matter. Most bankruptcies will have an impact on eligibility for private loan programs, including some school loan programs. Many private loan programs have credit criteria that preclude people with a bankruptcy within the past 7 or 10 years from borrowing without a creditworthy cosigner. There are, however, exceptions if the bankruptcy was initiated for reasons beyond the borrower’s control, such as extraordinary medical costs, natural disasters, or other extenuating circumstances.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)

Section 220 of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), P.L. 109-8, extended similar protections to “qualified education loans” starting on October 17, 2005, even when they are not funded or guaranteed by a nonprofit organization. Qualified education loans is defined to include any debt incurred by the taxpayer solely for the purpose of paying for qualified higher education expenses of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer.

BAPCPA also made it more difficult to file under Chapter 7. If the borrower’s income is above the median income in his/her state or is sufficient to repay 25% or more of his/her debt, the borrower will be forced to file under Chapter 13, which requires repayment over three to five years. BAPCPA also mandates credit counseling before a borrower can file for bankruptcy.

Limitations on Exception to Discharge of Private Student Loans

The extension of the bankruptcy exception to qualified education loans in 11 USC 523(a)(8)(B) cross-references IRC section 221(d)(1) for the definition of a qualified education loan. This section of the Internal Revenue Code requires the loan to be used “solely to pay qualified higher education expenses”.

So to qualify for this exception, the private student loan must be capped at the cost of attendance minus student aid, such as scholarships, and expenses paid for using amounts from employer tuition assistance, 529 college savings plans and prepaid tuition plans, US savings bonds and Coverdell education savings accounts. If a borrower were able to show that the loan exceeded the limits set by IRC section 221(d)(2), they might be able to argue that the loan was ineligible for bankruptcy protection and so should be subject to discharge.

IRS Publication 970 provides a safe harbor of 90 days before and after the academic period to which the expenses relate. Consolidation loans and other loans used to refinance a qualified education loan also qualify, provided that there was no cash out from the refinance (or that the cash out was used solely for qualified higher education expenses). Eligible student is defined by IRC section 25A(3) as a student enrolled at least half time in a degree or certificate program at a Title IV institution (per Section 484(a)(1) of the Higher Education Act of 1965).

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