The Debt that Refuses to Disappear: What Happens to a Student Loan if You File for Personal Bankruptcy?

Filing for personal bankruptcy is typically a last resort for individuals who are financially overwhelmed . In many instances, individuals who file suffer from excessive credit card debt, unforeseen medical expenses, loss of employment or a similar circumstance.

While Chapter 13 bankruptcy allows financially burdened individuals to repay their debts according to a court-approved repayment plan; Chapter 7 bankruptcy essentially wipes the slate clean by allowing individuals to liquidate their assets and discharge existing debts.

However, as Neil Burns, Senior Lawyer and Founder at The Law Office of Neil Burns, told New England Post, student loan debt does not typically disappear after filing for bankruptcy.

“Student loans are generally not dischargeable in bankruptcy,” said Burns, who continued, “This is, most consumer debt is dischargeable, but secured debt, such as mortgages and motor vehicle loans, and federally backed debt, such as student loans, are generally not dischargeable.”

Attorney and Counselor at Law, William Scannell (of the Law Offices of William E. Scannell), concurred that student loan debts “do not go away” with Chapter 7 bankruptcy. However, he also noted, that “you are not required to pay while in bankruptcy… your requirement to pay resumes when your Chapter 7 is completed, about four months after filing.”

For recent graduates struggling with student loan debt, like Kelly Monahan, the notion that such debt would not disappear with bankruptcy is disheartening.

“All I can say about the bankruptcy issue is that I would hope I never have to file for it, and the fact that I’d still have to worry about my student debt is discouraging,” Monahan told New England Post. “I do hope there is some kind of relief for those of us struggling to make it month-to-month and to stay on top of loan payments.”

Of course, Monahan is not alone in her desire for student loan debt relief.  Hundreds of thousands have signed an online petition calling for the federal government to forgive all current student loan debt.

“I can only assume that the premise of preventing student loans from being discharged in bankruptcy is to avoid the moral hazard (i.e. to prevent people from ‘planning’ on defaulting),” Tommaso Nicholas Boggia, an MPA candidate at Presidio Graduate School, told New England Post. Boggia was featured in an earlier New England Post story about student loan debt, opportunity cost and education financing reform.

Boggia continued that the moral hazard argument for not discharging student loan debt in bankruptcy is “absolutely ludicrous, as defaulting isn’t something done lightly, and has serious consequences on future abilities to borrow.”

Boggia sent along this graphic to illustrate the absurdity of being able to discharge other debts in bankruptcy, but not student loan debt.

According to Boggia, the moral hazard has now moved from the debtors to the banks. “Banks can now hand out student loans without any risk because they know they will get their money back eventually,” he said. “The inability of people to discharge their student loans in bankruptcy is one of the main reasons why the forgiving plan is such a good idea. People in default have hit rock bottom and won’t be able to contribute their full worth unless they are able to have a clean start.”

It is worth mentioning that there are special circumstances in which a bankrupt individual can have a student loan debt discharged. However, as lawyer Neil Burns highlights, most individuals are not faced with such circumstances.

“There are, of course, exceptions,” said Burns. “For student loans you have to prove substantial hardship, which, in reality, means being so severely ill that you will never work again.”

Related posts:

1. The Latest on Student Loan Debt Forgiveness: Exploring Opportunity Cost and Higher Ed Financing Reform
2. Should the Government Forgive Student Loan Debt? College Grads Say Yes; Economists Say No
3. Mission Accomplished: New England Post Finds an Economist* who Supports Forgiving Student Loan Debt
4. Forgiving Student Loan Debt as an Economic Stimulus; What Does a Local Economist Think?
5. Friendly’s Files for Ch. 11 Bankruptcy Protection

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Posted by erik devaney on Oct 24 2011. Filed under Featured - For home page featured article, General, Top Stories. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry