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Ask Dr. Don

Student loans in bankruptcy

Dear Dr. Don,
I have student loans that date back about 10 years.  I have made some payments on them, but for the most part they have either been deferred or defaulted on. 

Can I file bankruptcy on them, and if so, how?  If not, is there a way that I can start paying on them and get the interest to stop accruing.  My student loans total about $25,000, and I will never be able to pay them back with the interest accruing.
Grappling Ginger

Dear Ginger,
Discharging student loans in bankruptcy is very difficult to do.†† Provisions for discharging student loans in bankruptcy were changed in 1998.† The bankruptcy court has to rule that repayment would cause undue hardship for you or your dependents.† According to the Federal Student Aid Ombudsman (FSAO) Web site:

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

  • If you were forced to repay the loan, you would not be able to maintain a minimal standard of living.
  • There is evidence that this hardship will continue for a significant portion of the loan repayment period.
  • You made good-faith efforts to repay the loan before filing bankruptcy (usually this means you have been in repayment for a minimum of five years).
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Your loan will not be discharged if you are unable to satisfy any one of the three requirements. If your loan is discharged, you will not have to repay your loan, and all collection activity on these loans ends.

The Ombudsman site also describes situations where you may be able to cancel or discharge your student loan debt:

You may be able to rehabilitate your loans.† Under this program you work with your loan servicer to set up a monthly payment plan.† After successfully completing 12 monthly payments, the loan is sold to another loan servicer.† You then have nine years to pay off the loan balance.†

Loan rehabilitation can remove the default status of your prior loans from your credit report and, if you qualify, all derogatory information about the loans may be removed from your credit report.† The information on rehabilitating your student loans also comes from the Federal Student Aid Ombudsman site.† It's a fresh start, but you'íre not stopping interest from accruing and your payments over the nine years could be much higher then they were during the 12-month rehabilitation period.

Other than to say that you can't pay the loans with interest, you haven't described your financial situation.† I'd recommend that you consult with a bankruptcy attorney to discuss your chances at discharging these loans in a bankruptcy filing.† You will have to list all your debts when filing for bankruptcy, not just the student loans.† The attorney can also let you know whether a Chapter 13 filing with its repayment plan might make more sense then a Chapter 7 liquidation of nonexempt assets.

-- Posted: May 28, 2003

Read more Dr. Don columns
See Also
Recovering from a defaulted student loan
The basics of bankruptcy
Repaying student loans: You can go slow, but never stop
Financial advice glossary
More Dr. Don stories

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