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Student loans and bankruptcy

By Steve Bucci · Bankrate.com
Monday, November 4, 2013
Posted: 2 pm ET

One of the main features of bankruptcy is it gives people a clean slate -- wiping away financial burdens when their debt has become overwhelming.

It doesn't works that way, however, for student loans. Most people still owe on their student loans after filing for bankruptcy. In fact, many people who file a Chapter 13 bankruptcy, where they repay at least a portion of their debts, end up owing more on their student loans after completing a Chapter 13 repayment program. That doesn’t sound like a clean slate to me!

Why is this happening? In many cases, a Chapter 13 bankruptcy is structured in such a way that it does not allow consumers to make full payments on their student loans. A Chapter 13 program allocates all available income, net of some very spartan expenses, to repaying all your creditors over as much as a five-year period. The law requires that all debts be treated equally. The result is that at the end of the payment period, any debts left unpaid simply disappear or, as they say in court, they're “discharged.”

If any of that debt is in the form of a student loan, however, it probably hasn't been discharged. As a result, the student loan accumulates interest, late fees, and penalties over the period of the bankruptcy.

To me, this seems to be against the spirit of the original intention of bankruptcy. I think it would be a good idea to at least suspend interest charges, fees and penalties on student loans while consumers are under the protection of a Chapter 13 repayment program. The student loan lenders would still receive the principle balance and interest owed on the loan for the remainder of the loan term.

Because the knowledge acquired by a student loan can’t be repossessed or resold, there are very real grounds for them to be undischargeable in a bankruptcy. But, to treat all creditors fairly, it would seem that allowing interest, fees and penalties to accumulate while under the auspices of the court effectively makes some creditors more equal under the law than others.

I am a proponent for paying what you owe, but I recognize that unless we opt for endless collections or debtors prisons, an escape path must be in place for those hopelessly crushed by debt.

Do you have student loans? And do you think they should be treated like any other debt in a bankruptcy?

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