Understand bankruptcy and student loan debt

Rising college costs have led millions of students in the United States to obtain large loans to finance their education. According to the College Board, the price of attending a public four-year college has risen 27% beyond inflation in the past five years. To break it down further, costs have risen 24% at community colleges and 13% at private universities.

According to USA Today, student loans topped $ 100 billion four years ago for the first time, and the following year, outstanding student loans topped $ 1 trillion for the first time and have remained at that astronomical level. Between 2004 and 2012, total student loan balances nearly tripled due to a growing number of borrowers and higher balances per borrower. Sadly, nearly 17% of borrowers are behind on student loan payments, according to the Federal Reserve Bank of New York.

While many college students successfully land high-paying jobs after graduation and begin repaying those student loans, others cannot. While the economy has recovered somewhat since the recession of 2008 and 2009, unemployment or underemployment remains a big problem. Weak labor markets and stagnant incomes weigh heavily on graduates. Often times, student burden debt accumulates in mortgage, credit card, medical or other debt. In some cases, the only way to get out of that mountain of debt is to file bankruptcy.

People can file for bankruptcy under two chapters of the Bankruptcy Code. Chapter 7 is known as liquidation and involves the sale of all assets to help repay money owed to creditors. Chapter 13 is known as a reorganization and involves creating a plan to repay creditors.

While filing for bankruptcy can help clear the slate for many debtors, the burden of student debt is different. The Bankruptcy Code groups student loan debt with other types of debt that cannot be canceled, such as child support and criminal penalties.

Until 1976, all education loans could be canceled through bankruptcy. That year the Bankruptcy Code was modified, which prohibited the cancellation of university loans during the first five years of payment. After five years of repayment, the loans could be canceled due to bankruptcy or if the borrower was experiencing “undue hardship.”

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act, which gave more protection to federal and private student loans from bankruptcy protection. However, if the borrower could show the court that repayment of the student loan would cause “undue hardship,” the court could rule that the need for bankruptcy protection is justified and permitted.

The court uses a three-part test to determine hardship:

• It would be a hardship if you were forced to repay the loan but could not maintain a minimum standard of living for yourself and your dependents.

• There is evidence that this hardship will continue for a significant portion of the loan repayment period.

• You made good faith efforts to reimburse the load before filing for bankruptcy. Usually this means that you have been paying it back for a minimum of five years.

While you’re in bankruptcy, you’ll be protected from your student loan collection activities. However, during the bankruptcy process, your loans will continue to increase in interest, increasing your loan balance if no payments are made.

Bankruptcy is a long and very complicated process. To avoid feeling completely overwhelmed, it is wise to seek the services of an experienced bankruptcy attorney who can advise you on all of your options.