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Student Loans Difficult to Discharge

More than ever, it’s necessary to have a college degree to get a good job, but with tuition costs rising, two-thirds of all college students are graduating with some form of debt. Student loan debt in the U.S. totals more than $1.2 trillion, with the average student graduating with nearly $27,000 in loans after getting a four-year degree. Student loans are second only to mortgages as the largest form of consumer debt in the nation, according to an article by Forbes.

But unlike mortgages, student loans are extremely difficult to discharge in a bankruptcy if a person loses a job or has an illness and ends up underwater financially while still paying off their college debt.

Debtors with student loans who reorganize through a Chapter 13 bankruptcy sometimes end up between a rock and a hard place. They’re supposed to commit all of their disposable income toward paying their bills through the Chapter 13 plan, but they aren’t allowed to count their student loan payments as an expense.

Technically, under bankruptcy law student loans are treated as a non-dischargeable unsecured debt, like a credit card, but in reality they are more like something between an unsecured debt and a priority debt such as back taxes. During the three to five years that a debtor pays Chapter 13 payments, student loans get only the same fractional payment as other unsecured creditors — and they only get paid after debts such as a house, car, or taxes are paid. Unsecured creditors often don’t see any money from your plan until near the end, which means interest stacks up on your student loan debt. In the meantime, the student loan is not even receiving a full regular payment.

To put that into perspective, imagine a debtor owes $20,000 in student loans, and the Chapter 13 plan calls for unsecured creditors to be paid 10 cents on the dollar. The student loan lender would be paid $2,000 without interest, leaving a student loan principal of $18,000 still to be paid once the Chapter 13 is over.  That doesn’t include any interest that would continue to stack up while the regular loan payments are essentially suspended during the Chapter 13. In reality, if the debtor had a $200 monthly payment for five years, he or she would have paid $12,000 toward the student loan, not merely $2,000.

Some people have called for reforms to the bankruptcy laws to allow some student loan debt to be discharged. Sen. Elizabeth Warren of Massachusetts, for example, has said Congress should roll back a 2005 law that treats private student loans the same way as government-backed loans. Private loans tend to have higher interest rates and fewer deferment options than federal student loans. In fact, private student loans are much more aggressive and often bring lawsuits and attempt to garnish wages while continually racking up large interest, but yet cannot be discharged.

Unless Congress decides to act, student loans remain mostly bankruptcy-proof.

If you’re considering bankruptcy and have student loan debt, call Attorney Matthew Alden today at (216) 586-6600 for a free consultation.