Managing Student Loans: Chapter 13 Repayment Plans
There is no doubt that discharging student loans in a bankruptcy case is not an easy proposition. It’s not impossible, but the standard a debtor must meet – undue hardship – can be a steep climb.
If you can’t meet the undue hardship requirement, there may still be a way to use bankruptcy to manage your student loans by taking advantage of the repayment provisions of Chapter 13.
How Chapter 13 Works
Student loans are unsecured debt. That’s debt that does not have collateral attached to it that the creditor could sell to ensure payment. Some examples of unsecured debt include credit card balances, payday loans, unpaid medical and utility bills, and personal loans.
When you file a Chapter 13 case, you make a monthly payment to a Chapter 13 Trustee for three to five years. The Trustee distributes the money to your unsecured creditors who filed proper claims in your case.
Chapter 13 has several big advantages over other types of loan consolidation, debt management plans or debt settlement. For instance, in Chapter 13 you will not necessarily have to pay the entire sum of your unsecured debt. Instead, you pay according to your ability to pay based on a formula that takes into account your income and your reasonable and necessary expenses. If your income is higher than your expenses, the difference is called your "disposable income," and that forms the basis for your Chapter 13 plan payment.
Tom's Chapter 13 Plan
Let’s look at an example of a Chapter 13 plan. Tom has an income of $4,000 per month. When we add up all of his monthly living expenses, like mortgage and home maintenance, food, transportation, child care, medical, cell phone, utilities and trips to the corner coffee shop, the total comes to $3,700 per month.
Notice that we left out credit card bills (that’s because those will be paid through the Chapter 13 payment plan). The difference, $300, is Tom’s disposable income. The bankruptcy court would expect Chapter 13 payment to be no less than $300 per month for three to five years. The length of the plan depends largely on Tom's income level and family size.
Tom’s minimum payments on his credit card balances total more than $500 each month, and his student loan payment is $250. Perhaps you can see how Tom has been having a rough time of it. He’s been trying to stretch that $300 disposable income to cover $750 worth of payments, without a lot a success.
How Can Chapter 13 Help Manage Student Loans?
So how does a Chapter 13 help? Instead of continuing to struggle with those $750 payments each month, Tom will make one payment of $300 each month to the Chapter 13 Trustee who will distribute that $300 to Tom's creditors on a pro rata basis, meaning the payment is divided up according to the claim's percentage of the whole. At the end of Tom’s three to five year payment plan, he will probably not pay off 100% of his unsecured debt, but because he is in a Chapter 13 case, any remaining balances on his credit cards, medical bills, and most other unsecured debt will be forgiven – all because the Chapter 13 plan represented his best effort.
Student loans, however, are not automatically discharged. So how can a Chapter 13 plan help Tom? By allowing him to treat those student loans just like any other unsecured debt during that three to five-year plan, and pay them each month as a pro rata portion of the Chapter 13 Plan payment. Therefore, instead of making that $250 payment on the student loan plus the minimum payments on the credit cards and other bills, Tom will make a total payment of $300 for all of that. About $100 of that payment will go to the student loan servicer, and $200 will be divided among the other unsecured creditors. To learn more about Chapter 13 plans, see our article What is Chapter 13 Bankruptcy?
So, is there a catch? In a way, yes. While this type of Chapter 13 plan will give Tom some breathing space, it isn't going to help him make much progress toward paying off those student loans.
During his Chapter 13 plan, the loan servicer cannot take any collection action against Tom, but interest continues to accrue. When he completes his Chapter 13 plan, the servicer will re-evaluate the loan accounts and set a new payment schedule for Tom. By that time, we hope that he will have a higher income and can better afford the new payment schedule or take advantage of repayment programs like income-based repayment or public service loan forgiveness. He may even choose at that point to ask the Bankruptcy Court to discharge his remaining student loans because of undue hardship.
Lots of different factors affect how Chapter 13 plans work and who gets paid. To have your circumstances evaluated, call a qualified consumer bankruptcy attorney. Most offer a free consultation with no obligations.
For lots more information on managing your student loans during difficult financial times, see our articles on the following issues:
When You Can't Make Your Payments
Student Loans in Bankruptcy
Using Chapter 13 Repayment Plans