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What to know about student loan debt and bankruptcy

| Dec 17, 2020 | Blog, Chapter 7 Bankruptcy |

Debtors in North Carolina who see no way out of debt have the option of bankruptcy to remove certain debts. Chapter 7 helps debtors discharge certain unsecured debts such as medical bills and credit card debt. Student loans are a common debt, but they get treated differently from other debts in bankruptcy.

How Chapter 7 bankruptcy works

Chapter 7 settles secured debt through a liquidation of assets to pay creditors through a court-appointed trustee. However, only non-exempt property, such as vacation homes, second vehicles or valuable jewelry, can be sold by the trustee.

Before the bankruptcy, creditors usually attempt to collect debt or garnish wages. The automatic stay prevents creditors from seeking collection or garnishment. After creditors get paid as much as possible, the remaining debt gets discharged.

Student loans under Chapter 7

Contrary to popular belief, student loans can get discharged in bankruptcy, but it requires stricter criteria, and courts often hesitate to discharge them. The debtor must qualify under undue hardship to get out of paying the loan or only pay a portion. This process requires filing an adversary proceeding, which separates it from the main bankruptcy case.

Several factors or tests could be used to determine hardship that vary by court. Most courts use the Brunner test, which applies the following criteria:

  1. If the debtor has to pay the loan, it would drop them below the minimal living standard.
  2. The debtor has made a good faith effort to repay the loan.
  3. The debtor expects their situation to be the same for an extended time period.

Chapter 13, often called reconstruction or wage earner’s plan bankruptcy, gives the debtor an option to slowly repay the loan under a payment schedule they can handle. However, they need a source of income to qualify.

Chapter 7 or 13 bankruptcy doesn’t have an easy process, nor is it without repercussions. However, even if the debtor has to pay a portion of the loan, they still may come out better able to provide for themselves. It’s important to consult a lawyer before filing because laws can be complex.