Federal Student Loan Bankruptcy: “Pay-As-You-Earn” may be the only solution.

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According to statistics from the Department of Education, more than seven million Americans are in default on their student loans – which means that they haven’t made a payment in three months. Collectively there is about $90 billion in default just for federal student loans, and when you fail to repay a federal loan, the government can withhold your tax refunds or garnish your wages. According to the Consumer Financial Protection Bureaus, lenders don’t need a court order to garnish your wages.

There are certain kinds of private student loans that can be relieved by declaring bankruptcy. If you used the privately funded loan as tuition to a vocational school, beauty school, truck driver school, car mechanic school, or flight school, for example, then you may be entitled to at least a partial discharge of your private student loan debt. There is no guarantee, but it is worth the effort to discuss the debt with a qualified bankruptcy attorney.

Unfortunately, many kinds of student loan debt cannot be discharged by bankruptcy – and federal loans seldom qualify. So you don’t want to bank on the fact that you can sidestep repayment of federal student loans by filing for bankruptcy because it might not work. You could emerge from the proceedings still owing the full amount, with the added problem of a bankruptcy in your credit history that may make it harder to qualify for credit cards, buy a home, or even land the job you want.

Federal Repayment Plans

What are you supposed to do if you are out of college and have Uncle Sam breathing down your neck because you owe him money? Before you give up hope, there is one effective way to deal with federal student loan debt, and that is through an approved repayment plan program. Millions of borrowers are enrolled in a regular run-of-the-mill, 10-year repayment program. There are also plenty of people signed up for plans that allow for extended payback periods or graduated plans that slowly increase the amount paid over time, while you are hopefully advancing in your career and experiencing progressive salary and income growth. Those are fine, but if you are sliding into default and foreclosure, you need a much more accelerating solution such as the “Pay-As-You-Earn” plan.

The Pay-As-You-Earn Solution

What distinguishes this plan from others is that it ties your monthly federal student loan payments to how much you earn and was designed specifically to serve students who are experiencing financial hardship. Not everyone is eligible, and only about 50,000 people are currently enrolled – but that may be because most people have never heard about it. To qualify you have to have at least a partial financial hardship. The way the program defines “partial hardship” is, the amount you have to pay on federal student loans under the standard 10-year plan must be higher than what you’d have to pay with Pay-As-You-Earn.

Yes, there are other complicated eligibility requirements that must be satisfied, too. If you get into the program, though, it’s worth it. In a nutshell, those enrolled will never have to pay more than 10 percent of their discretionary income toward student loan repayment. Discretionary income, incidentally, takes into account a certain amount of your income reserved for basic living expenses. You can check out the definitions and rules and learn more at the Pay-As-You-Earn program’s website.

Major Benefits of Pay-As-You-Earn

Once you’re in the program you can keep making payments under its more lenient terms and conditions, even if your income improves such that you are no longer experiencing financial hardship. In the event thatyour Pay-As-You-Earn monthly payment amount is not big enough to cover the interest that accrues on your loans each month, the government will start picking up the tab on unpaid accrued interest on your Direct Subsidized Loans and on the subsidized portion of your Direct Consolidation Loans. Uncle Sam will continue to do so for up to three consecutive years from the date you began Pay-As-You-Earn repayments.

If you repay your loan as agreed under the Pay-As-You-Earn program – and meet a few other requirements – then anything you still owe after 20 years will be waived or forgiven. You may still be liable for IRS taxes on that forgiven balance, but you won’t have to pay the actual principal amount leftover on your student loan debt. You may also qualify for loan forgiveness by working full time for a public service organization for at least 10 years in a row, under what is known as the Public Service Loan Forgiveness Program.

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