Chapter 13 is a type of bankruptcy case that gives consumers a chance to restructure their debt. There are many reasons why consumers file Chapter 13 bankruptcy cases. Often it is to stop a home foreclosure or auto repossession, deal with tax obligations, or repay burdensome debt under more favorable terms. Like many consumers, these Chapter 13 filers also have student loan debt. Because students loans are not dischargeable in bankruptcy except when the borrower can prove undue hardship, many Chapter 13 filers want to stay in their repayment plans (including the income-driven repayment) while they are in bankruptcy.
Payment of student loans in Chapter 13 is a win-win outcome for borrowers, the Department of Education, and taxpayers. So why are borrowers struggling to stay in repayment while in Chapter 13?
Is repayment allowed under bankruptcy law? In many cases, the answer is yes. Consumers in Chapter 13 cases submit a plan to the court that sets out how their creditors will be paid. Many bankruptcy courts approve Chapter 13 plans that let consumers continue to make their regular monthly payments (which could be IDR payments) to student loan creditors while they are in bankruptcy. These courts find that the same law that permits similar treatment for other long-term debts such as home mortgages also applies to student loans. Some courts, however, will approve this separate treatment of student loan creditors only if the plan does not unfairly treat other similar creditors. Borrowers should check with their bankruptcy attorney about what is possible in their area.
Do the Department’s regulations allow repayment? Unfortunately the answer to this question is not clear. There is a Department regulation that places student loans in forbearance when they file for Chapter 7 and lasts until the bankruptcy is concluded. Perhaps because the Department has not issued a regulation or public guidance that specifically addresses the Chapter 13 situation, student loan servicers treat Chapter 13 filers as if they have filed a Chapter 7 and place their loans in forbearance. This prevents borrowers from staying on IDR plans and getting the benefit of payments towards loan forgiveness during their Chapter 13 case. Student loans are effectively “put on a shelf” during the case. Even worse, borrowers can emerge from Chapter 13 further in debt because interest continues to accrue on their loans during the bankruptcy.
Advocates at NCLC and the National Association of Consumer Bankruptcy Attorneys have asked the Department to address this problem. There has been some progress. In a few individual cases, consumer attorneys have been able to negotiate terms of Chapter 13 plans with the Department that allow borrowers to enroll and participate in IDR plans. This is a good first step but more than an ad hoc, case-by-case approach to this issue is needed. Most borrowers and their attorneys still expect that the Department and its servicers will treat student loans in Chapter 13 as if they are in forbearance. The Department should issue clear public guidance on student loan servicing for borrowers in bankruptcy so that all participants (consumers, attorneys, servicers, trustees, and bankruptcy courts) know what repayment options are possible during a Chapter 13 case.
Why hasn’t the Department addressed this issue? We suspect that the Department has not adopted clear guidance on the servicing of loans in Chapter 13 out of concern that student loan servicers will somehow violate bankruptcy law, namely the automatic stay. This protection for consumers from collection actions when they are in bankruptcy does not prevent creditors from accepting payments, providing monthly statements, or processing IDR applications. Concerns about violating bankruptcy law had been used by mortgage servicers for many years as an excuse for inadequate servicing of mortgage loans in Chapter 13 cases. While not all mortgage servicing problems have been resolved, the servicing industry and regulators have come to recognize that normal servicing protocols can be adapted to conform to bankruptcy law. Recently proposed regulations from the Consumer Financial Protection Bureau on providing monthly billing statements to mortgage borrowers when they are in bankruptcy also provide an excellent analysis of bankruptcy loan servicing issues and should serve as a template for any guidance developed by the Department.