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
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."