How Does Bankruptcy Affect Eligibility for Student Financial Aid?
June 06, 2011
How does a chapter 13 bankruptcy affect financial aid? Would it be difficult to get financial aid for my child because my husband and I filed chapter 13 about 2 years ago? — C. F.
A previous bankruptcy can affect eligibility for some education loans but it does not affect eligibility for other forms of financial aid.
The Bankruptcy Reform Act of 1994 (P.L. 103-394) amended the US Bankruptcy Code at 11 USC 525(c) to prohibit denial of government student grants and loans based solely on the student’s or borrower’s past or present filing of a bankruptcy petition. The only exception is the Federal PLUS loan.
A child is eligible for federal student loans, such as the Stafford loan, regardless of the parent’s history of bankruptcy. The Stafford loan does not depend on the borrower’s credit history in any way.
A parent’s history of bankruptcy also does not affect the child’s eligibility for federal grants, state grants, scholarships and money from the college, nor student employment programs like Federal Work-Study. The parent may also be eligible for tuition installment plans because these plans are usually structured as a qualified education loan to make them difficult to discharge in bankruptcy.
However, parents are ineligible to borrow from the PLUS loan program for five years from the date of the bankruptcy discharge. (By law, PLUS loan borrowers must not have an adverse credit history. The regulations define an adverse credit history as having had a bankruptcy discharge, foreclosure, repossession, tax lien, wage garnishment or default determination in the last five years or a current delinquency on any debt of 90 or more days.)
If a child’s parent is denied a PLUS loan because of an adverse credit history, the child becomes eligible for increased unsubsidized Stafford loan limits. The unsubsidized Stafford loan limits are increased by $4,000 per year during the freshman and sophomore years and $5,000 per year during the junior and senior years. Some families prefer the additional unsubsidized Stafford loan eligibility because the unsubsidized Stafford loan has a fixed 6.8% interest rate, which is lower than the 7.9% interest rate on the PLUS loan.
(A previous Ask Kantro column, How does bankruptcy affect PLUS loan eligibility, explains why a PLUS loan denial because of a prior bankruptcy does not violate the Bankruptcy Reform Act of 1994.)
Parents who have been denied a PLUS loan because of an adverse credit history can still obtain a PLUS loan with an endorser (cosigner) who does not have an adverse credit history. The endorser must be someone other than the dependent student for whom the PLUS loan is borrowed. Parents can also appeal an adverse credit history determination to the US Department of Education by documenting extenuating circumstances. (The extenuating circumstances must apply to the parents, not the endorser.) The US Department of Education appears to sometimes consider a chapter 13 conversion of a chapter 7, 11 or 12 bankruptcy to be sufficient grounds for granting such an appeal.
Parents with a recent bankruptcy will be ineligible to serve as the borrower or cosigner on most private student loans. The provisions of the Bankruptcy Reform Act of 1994 apply only to federal student loans, not private student loans. Most lenders of private student loans ask about bankruptcy filings in the last 7 or 10 years. It really doesn’t matter whether the filing was under chapter 7, 11, 12 or 13, as the lenders will be wary of lending money to anybody with a recent bankruptcy filing.
Parents who have had a bankruptcy should also ask the college’s financial aid office for a professional judgment review. College financial aid administrators are split on whether to make adjustments to income for mandatory court-ordered monthly payments to the bankruptcy trustee. Some do, most don’t. The appeal should mention any extenuating circumstances, especially aspects of the situation that were beyond the parent’s control (e.g., bankruptcy because of medical bills or a natural disaster, or if the debtor was forced into bankruptcy involuntarily by creditors). The Higher Education Act of 1965 permits financial aid administrators to exclude from income the proceeds of the sale of a farm or business asset if the sale results from a “voluntary or involuntary foreclosure, forfeiture, or bankruptcy or an involuntary liquidation.”