Does Filing Bankruptcy Affect Financial Aid?

For many, a college degree is a requirement for the career path they would like to pursue. Unfortunately, with the price of tuition, housing, and other fees, a college education is an expense that the vast majority of people cannot afford to pay for out of pocket. In fact, according to the Education Data Initiative, the average cost of college is now $38,270 per year, which is a staggering number when compared to the median family incomes. This results in the need for financial aid. However, what if you have declared bankruptcy in the past or are currently going through the bankruptcy process? Will this disqualify you from receiving financial aid? Well, let’s find out. 

Understanding Financial Aid

First, let’s make sure you have a full understanding of exactly what financial aid is. Financial aid refers to money provided by a third party for the purpose of paying for a college education and the costs associated with it. This can take many different forms, including grants, scholarships, work-studies, and loans. Student loans are the most common and often provide much larger sums than the other forms of financial aid. The major types of student loans are:

• Perkins Loans: Federal loans known for their low interest rates. These are intended for low-income graduate and undergraduate students. Perkins loans have been capped at $27,500 for undergrads and $60,000 for grad students since 2014.
• PLUS Loans: Federal loans given to grad students and the parents of undergraduate students. These loans are provided by the U.S. Department of Education, and are capped at the total cost of attendance after subtracting other sources of financial aid.
• Private Loans: Loans provided by traditional lenders, such as banks and credit unions.
• Stafford Loans: Federal loans, with subsidized Stafford loans for undergrads and unsubsidized Stafford loans for graduate students. Regardless of if they are graduate or undergrad, all students apply for Stafford loans by completing and submitting FAFSA (Free Application for Federal Student Aid).

All of these loans allow many students to obtain a college education when they otherwise would not be able to afford to attend college. 

How Bankruptcy Impacts Financial Aid

The exact impact of bankruptcy on financial aid will vary depending on the type of financial aid. In general, grants, scholarships, and work studies will not be impacted at all. These forms of financial aid take into consideration academic merit and financial need. They do not consider credit history when determining a student’s eligibility, so a prior bankruptcy will not even be taken into consideration. 

On the other hand, financial aid which takes the form of loans can be impacted by a bankruptcy. Perkins loans and Stafford loans, like the other forms of financial aid previously mentioned, determine eligibility based on financial need only, not credit history, meaning that bankruptcy should have no impact on these types of loans. However, private and PLUS loans do not operate like this. PLUS loans require a healthy credit history. Experiencing mortgage foreclosure, wage garnishment, vehicle repossession, or Chapter 7 or Chapter 13 bankruptcy will result in ineligibility to receive PLUS loans. Similarly, private loans require good credit history, though exact requirements vary depending on the lender. A prior bankruptcy will make it very difficult to receive any private student loans. However, both PLUS and private loans can still be received even with a prior bankruptcy, provided the borrower has a cosigner with healthy credit. 

Can You Get Financial Aid While in Chapter 13?

What if your bankruptcy is not in the past, but is actively happening? Fortunately, you can still qualify for financial aid while in chapter 13 bankruptcy. As mentioned, most forms of financial aid are need-based. This means that your credit history is usually not considered when determining eligibility. Only PLUS and private loans will be difficult, if not impossible, to obtain while undergoing chapter 13 bankruptcy. 

Subsidized vs. Unsubsidized Loans

Student loans come in two forms, subsidized and unsubsidized. So, what’s the difference between the two? Well, subsidized loans are only given to undergraduate students who have demonstrated financial need. With these loans, the Department of Education covers the interest on the loan while you are enrolled in school at least half-time, during the six-month grace period after leaving school, and during your deferment period. 

On the other hand, there are unsubsidized student loans. These loans are also available to undergraduate students as well as graduate and professional students. The main thing to keep in mind when it comes to unsubsidized loans is that interest on these loans starts accruing as soon as the loan is disbursed. For this reason subsidized loans should always be chosen over unsubsidized when possible. 

Bankruptcy and Private Student Loans

Most people have heard that bankruptcy does not discharge student loans. This is still the general rule.  However, both federal and private student loans can be discharged through bankruptcy if you can prove that repayment of the loan(s) would cause “undue hardship”.  It should be noted that this is difficult to do because the courts have set this undue hardship standard extremely high.  

Loan Repayment Plans After Bankruptcy

During a chapter 13 bankruptcy, you are able to develop a plan to repay all or part of your debts, including private or federal student loans. This repayment usually takes place over 3-5 years, though it can be longer. The payments should be designed so that you can make them while still being able to afford your day-to-day costs such as food and housing. 

After the closure of either a Chapter 7 or Chapter 13 bankruptcy case, any non-discharged student loans must be repaid according to the terms of the loan.  

Rebuilding Financial Health

After bankruptcy, your focus should be on rebuilding your financial health. Some steps you should take include:

• Create a detailed budget. Be sure to include all of your living expenses. 
• Slowly build an emergency fund by saving a small amount of money each month. Make sure to include this in your budget.
• Begin rebuilding your credit by paying all bills on time, keeping credit utilization low, and avoiding unnecessary credit applications. 
• Seek financial counseling, if needed. 
• Be cautious about incurring large motor vehicle debts that require payments that strain the budget. 

If you follow these steps and stick to them, you will be well on your way to rebuilding your financial health. This can be a long process, but it is well worth it in the end.