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Creative Options for Student Loans in Chapter 13

May 25, 2016 by Shannon Doyle

Student LoanStudent loans are very difficult to get discharged in bankruptcy; however, don’t assume you can’t help your debtor with their student loans. In fact, you may be doing your client a huge disservice if you aren’t considering the following options for debtors with student loan debt: (1) designate a separate class, (2) file a Chapter 20, (3) Consolidate and/or apply for an Income Based Repayment plan for federal student loans, (4) mediation, and (5) discharge. This article will address the benefits of designating a separate classification for federal and private student loans.

Pursuant to 11 U.S.C. §1322(b)(1) you can designate a separate class for unsecured creditors as long as you don’t “unfairly” discriminate against any class. By designating a separate class in the chapter 13 plan, you will help your debtor to (1) avoid the 18.5 % default rate on federal student loans, (2) stay current on Income Based Repayment plans toward the goal of forgiveness and (3) protect co-signers (especially for private student loans).

How does it work? Let’s say your debtor has $300k in total unsecured debt, $200k of which is federal student loans, $50k of which is private student loans and $50k in other general unsecured debt. Let’s say your client has disposable income of $1k per month for 60 months and is currently on an Income Based Repayment plan paying $250 per month toward federal student loans.

In a traditional chapter 13 plan, the creditors would receive the following:

Federal Student Loans Private Student Loans Other General Unsecured Creditors
$40,000 $10,000 $10,000

 

In this scenario, debtor exits chapter 13 with large balances owed on the federal and private student loans. But if you were to designate a separate class for each creditor, they would receive the following (excluding fees and costs):

Federal Student Loans Private Student Loans Other General Unsecured Creditors
$250 on IBR works toward goal of forgiveness $583 x $60 = $34,980 (Debtor exits chapter 13 with much less debt) $167 x 60 = $10,2020 (Same amount they would receive under the traditional plan)

 

Many attorneys assume they can’t separate the classes because their trustee objects. In a webinar I recently attended on this issue, Laurie Weatherford, a Chapter 13 Trustee in the Middle District of Florida stated that she used to routinely object to separate classification assuming it was unfair discrimination. But now she supports this strategy as an effective way to help debtors without hurting creditors. The Courts are looking at this more closely now and balancing the benefit of the debtor staying current and curing pre-petition arrearages on their student loans with the detriment to other unsecured creditors by separate classification.  Let me be clear, you can’t separate a class that will result in disproportionate payout to student loan creditors at the expense of other unsecured creditors. Nondischargeabliity alone does not allow discriminating against other unsecured creditors, and avoiding harm to the debtor is not a reasonable basis for discrimination. Further, discrimination is not necessary or reasonable.  When proposing a plan that separates student loan debt into a separate classes, identify who will object. A servicer is unlikely to object if they are getting paid. Unsecured creditors are unlikely to object. The most likely party to object is the chapter 13 trustee. The trustee may object to protect precedent, maintain strict code adherence or because of the degree of disparity in treatment of unsecured creditors. But things are changing in this arena and as long as you can show the separate class does not unfairly discriminate, and establish debtors’ good faith you should be able to persuade the Court that designating a separate class is the best possible outcome for debtor is achieving a fresh start.


eBankruptcy Assistants, Inc. does not engage in the unauthorized practice of law. We never give your clients legal advice. All case analyses’ are done in a consulting capacity for the attorney of record. We do not represent individual debtors. We work solely for bankruptcy attorneys.