All bankruptcy cases are heard in federal court.
Bankruptcy is a legal process designed to provide honest but unfortunate debtors the opportunity for a fresh financial start. There are a number of different types of bankruptcy that are available to debtors, but the two most common forms for individuals are Chapter 7 and Chapter 13. Both types of bankruptcy provide for a discharge of debts, but with rare exceptions, neither will discharge a student loan.
Type of Loan
There are two primary types of student loans: federal student loans, such as those made under the Perkins loan program, and private student loans. The factor that determines if a student loan qualifies for discharge under bankruptcy proceedings is whether the loan qualifies as a tax deduction. Loans that qualify as a tax deduction are not eligible for discharge under any chapter of the bankruptcy code, regardless of whether or not the debtor claimed the deduction on his tax return.
Chapter 7
Chapter 7 bankruptcy is the most common type of bankruptcy filed by individual debtors. It is sometimes referred to as a straight or liquidation bankruptcy. The debtor's non-exempt assets are turned over to a court-appointed trustee. The trustee liquidates these assets and distributes the proceeds to creditors to satisfy their claims. Once all distributions are made, the bankruptcy judge may declare the debts discharged, which means the debtor no longer has a legal obligation to repay them. Provisions of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 make both federal and private student loans ineligible for discharge through Chapter 7 bankruptcy.
Chapter 13
Chapter 13 bankruptcy is sometimes referred to as the wage earner's plan because it is available to debtors who are gainfully employed but unable to meet all of their obligations. Individuals who file for Chapter 13 bankruptcy protection are allowed to keep their assets while a court-appointed trustee works out a repayment plan that typically lasts from three to five years. Student loans may be included in the repayment plan, which may significantly reduce the amount of the debtor's monthly payments. Student loans cannot be discharged at the end of the repayment plan along with other debts, and the debtor will still be obligated to repay the remainder of his student loans.
Undue Hardship
In rare instances a bankruptcy judge may grant a discharge of student loans based on undue hardship to the borrower or the borrower's dependents. Debtors must prove that although they have made an honest attempt to repay their student loans, they are unable to do so and still maintain a minimum standard of living. They must also demonstrate that their current financial situation is unlikely to significantly improve in the future. Requests for discharge due to undue hardship must be made in a separate motion. Undue hardship is difficult to prove unless the debtor is physically not capable of working, according to Sallie Mae.
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