Discharging Private Student Loans in Bankruptcy [Guide]

Can private student loans be discharged in bankruptcy? The answer is yes, they can be, though it’s not a simple process. Unlike common belief, discharging private and even federal student loans through bankruptcy is possible, albeit more challenging than discharging credit card debt, medical bills, or other types of debt.

Related: Can You File Bankruptcy on Student Loans?

Federal student loans are particularly difficult to discharge in bankruptcy due to features such as income-based repayment plans, deferments, forbearances, and loan forgiveness programs. These benefits complicate the task of demonstrating ‘undue hardship,’ a prerequisite for discharging student loans in bankruptcy.

Conversely, private student loans don’t come with the same protections offered by the U.S. Department of Education, making them a slightly easier target for discharge. Nevertheless, you’ll still need to convince a judge of your financial hardship, which is never an easy task. But compared to federal loans, the odds are somewhat more favorable.

Key Takeaways

• Bankruptcy Process: Understanding the steps involved in bankruptcy, from launching an adversary proceeding to proving undue hardship via the Brunner Test, is vital. Knowledge of the differences between Chapter 7 and Chapter 13 bankruptcy types is essential for borrowers seeking to discharge student loans.

• Consider Alternatives: Don’t rush into bankruptcy; consider all options first. Income-driven repayment plans, loan consolidation, or refinancing might offer better solutions for your financial situation.

• Changing Landscape: Stay updated on evolving regulations and laws. Recent trends indicate a future where private student loan dischargeability might be more forgiving, potentially revolutionizing the debt relief process

Related: Why Can’t You File Bankruptcy On Student Loans?

To grasp the concept of private student loans, we need to understand three key aspects:

• Origination: Private student loans are different from their federal counterparts, originating from private lenders, not the government. These loans, designed to cover “qualified higher education expenses,” are categorized as education loans, not personal loans.

• Repayment Options: Unlike federal loan borrowers who can access various repayment options, including income-driven plans, private student loan borrowers often face more limited choices and stricter terms. Additionally, private student loans may carry variable interest rates, which can increase the difficulty of repayment. Unlike federal loans, private student loans may not offer loan deferment, forbearance, or loan forgiveness programs.

• Misleading Practices: Some student loan companies have been known to spread misleading information about bankruptcy protections. They may even attempt to collect on debts already discharged by a bankruptcy judge. For instance, Navient did this for years, trying to collect on old Sallie Mae loans it inherited, but recently agreed to stop this practice as part of a class action settlement.

These three points suggest why discharging private student loans might be easier than federal ones.

The origination of loans from private lenders, coupled with potentially more challenging repayment terms, can create a greater burden on borrowers.

This burden might meet the criteria for ‘undue hardship,’ which is critical for discharging student loans in bankruptcy. We’ll delve deeper into this later.

The landscape of private student loan discharge changed significantly in 2005 with the introduction of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). This Act made discharging private student loans more challenging, especially those loans designed to cover the cost of a student’s attendance.

Unfortunately, some lenders and lawyers exploited this change. They created loans that ostensibly aligned with the cost of attendance but, in reality, often exceeded it by thousands of dollars.

These lenders typically didn’t require proof of the cost of attendance. The student’s signature was all that was needed, and the funds were deposited directly into the student’s bank account.

Given this history, it’s essential to know the nature of your loans, particularly if you’re considering bankruptcy discharge.

So how do you determine if you have private student loans?

1. Check your credit report.

2. Compare it against the loans listed for you by the Department of Education.

3. You can do this by creating an account with StudentAid.gov.

4. Any loan visible on your credit report but not listed on the website is likely a private loan.

Student loan debt is a type of unsecured consumer debt, similar to credit card or medical debt. But it has its own unique set of rules when considered in the context of bankruptcy.

Related: Are Student Loans Consumer Debt?

Unlike most other types of unsecured debt, discharging student loan debt during bankruptcy requires borrowers to demonstrate undue hardship through additional procedures.

Specifically, they must initiate a separate lawsuit known as an ‘Adversary Proceeding’ and pass a stringent ‘Brunner Test‘ that involves proving continued hardship, good faith efforts to repay the loan, and an inability to maintain a minimal standard of living if forced to repay the loan.

If this process seems daunting, don’t worry. There are other ways to manage your student loan debt:

• Negotiating a Settlement with Your Lender: You can often work directly with your lender to negotiate new repayment terms that are more manageable based on your financial circumstances.

• Refinancing Your Loan: Some borrowers may find relief by refinancing their student loans. This could potentially lower your interest rate or extend your repayment term, making monthly payments more affordable.

• Income-Driven Repayment Plans: These are programs offered by the federal government that calculate your monthly loan payment based on your income and family size.

Let’s dive into two options you have – Chapter 7 and Chapter 13 bankruptcy.

• Chapter 7 Bankruptcy: Often the go-to option because of its lower cost and quicker process. But here’s the kicker – it doesn’t shield your cosigners, who could be pursued for loan payments.

• Chapter 13 Bankruptcy: Although it’s a bit more costly and time-consuming, it does have a silver lining. It safeguards your cosigners from being badgered about your student loans, and it doesn’t tarnish their credit history with bankruptcy.

Related: What Happens to Student Loans in Chapter 13?

Once you’ve picked your bankruptcy type, here are the next steps:

• File your bankruptcy paperwork with the court.

• Kickstart the bankruptcy process with meetings with the trustee and your creditors.

• Launch an adversary proceeding. Think of this as a mini lawsuit within your bigger bankruptcy case, arguing for a private student loan discharge.

In this adversary proceeding, your mission is twofold:

• Prove that paying back your private student loans would send you into undue hardship.

• Convince the judge that your loans aren’t just a current pain but will continue to drag down your standard of living in the foreseeable future.

Related: How to File an Adversary Proceeding for Student Loans

The Brunner Test, a legal litmus test, sizes up ‘undue hardship’ by looking at:

• Your ability to keep up a minimal standard of living while dealing with loan repayments.

• The persistence of your financial woes.

• Your earnest efforts to repay the student loan.

Private student loans, along with certain other types of educational debt, are generally protected from discharge under Section 523(a)(8) of the U.S. Bankruptcy Code. This section safeguards three kinds of education debt:

1. Loans and benefit overpayments backed by the federal government or a nonprofit

2. Qualified private educational loans

3. Obligations to repay funds received as an educational benefit, scholarship, or stipend.

The code offers some room for discharging private student loans in bankruptcy, but it’s not easy. Specifically, you’ll have to prove you meet the undue hardship standard. This standard requires you to convincingly demonstrate two key points:

1. You’ve made a good-faith effort to repay the debt. This can include seeking employment, maximizing income, minimizing expenses, and even making at least one student loan payment or negotiating a repayment plan with the lender.

2. Given your current and projected financial situation, you are unable to maintain a minimal standard of living for yourself and your dependents while keeping up with student loan payments throughout the repayment period.

Bankruptcy laws concerning private student loans are not static and can be influenced by both court rulings and legislative efforts. Recent developments in both these areas indicate shifts in the landscape that could make it easier for borrowers to discharge their student loans.

Court Rulings

Recent court rulings have set a precedent for the possibility of discharging private student loans without having to prove undue hardship under specific circumstances:

• The loan was not backed by a nonprofit: If no nonprofit organization supported the loan, it might be eligible for discharge.

• The loan exceeded your cost of attendance: If the loan amount surpassed your school’s official education expenses, it could be discharged because it’s not a qualified education loan.

• The loan was not a conditional grant of money: Loans that were not conditional grants, such as ROTC scholarships, may be discharged.

For example, a New York-based federal appeals court in July 2021 refused to dismiss a lawsuit against Navient, ruling that certain private student loans are not automatically protected from discharge in bankruptcy. And in August 2020, the 10th Circuit federal appeals court, based in Denver, Colorado, eliminated $200,000 in private student loan debt for a Colorado couple with 11 private student loan accounts.

Proposed Legislation

Several pieces of proposed legislation proposed by members of Congress could make it easier to discharge student loans in bankruptcy:

• The Fresh Start Through Bankruptcy Act of 2021 would allow borrowers to discharge private and federal loans ten years after the first payment becomes due, regardless of the borrowers’ personal financial situations.

• The Private Student Loan Bankruptcy Fairness Act of 2019, re-introduced in August 2021, seeks to make student loans issued by private lenders automatically dischargeable in bankruptcy, eliminating the need to file an adversary proceeding.

• The Medical Bankruptcy Fairness Act of 2021 would enable “medically distressed debtors” to wipe out their student loans without having to meet the undue hardship standard or pass the Brunner Test.

Though none of these pieces of legislation have passed as of yet, they indicate ongoing efforts to change the rules around student loan discharge in bankruptcy.

The implications of these court decisions and potential legislative changes could make it easier for borrowers to discharge private student loans in bankruptcy. But until such changes are firmly established, borrowers may need to explore other alternatives for managing their student loan debt

While bankruptcy can provide relief from overwhelming debt, it also comes with long-term impacts, including a significant hit to your credit score that can make obtaining new credit more difficult. Instead of filing for bankruptcy, private student loan borrowers can explore various alternatives. These options may offer financial relief without the significant drawbacks of bankruptcy:

1. Student Loan Refinancing: A process where a private lender pays off your existing loans and creates a new loan with new terms, potentially with a lower interest rate. Be aware that if you refinance federal loans, you’ll lose federal loan benefits, including access to income-driven repayment plans and potential loan forgiveness.

2. Income-Driven Repayment Plans: While typically not available for private student loans, federal student loan borrowers can switch to a repayment plan based on their income and family size. This can lower your monthly federal loan payments, freeing up more income to tackle private student loan debt.

3. Loan Forgiveness Programs: Certain professions, particularly those in public service, might qualify for loan forgiveness programs. These can forgive part or all of your federal student loan debt. This has become especially relevant as the Biden administration has implemented the Income-Driven Repayment (IDR) Waiver and payment count adjustment, resulting in $39 billion in loan forgiveness for over 800 thousand Americans who’ve had their loans for more than 20 years. More forgiveness is expected to come from this program. In addition, some state-sponsored programs offer private student loan repayment assistance or even forgiveness.

4. Debt Settlement: Depending on how much you owe and your lender, you may be able to negotiate a settlement to pay less than you owe, either in a lump sum or over a few months. Keep in mind that forgiven debt can be considered taxable income. I’ve helped many people settle their student debts rather than file bankruptcy to get out of their loans.

Navigating the intricacies of discharging private student loans through bankruptcy can seem overwhelming, but remember; it’s becoming more feasible each day. Still, it’s not as straightforward as it is for other consumer debts. There are hurdles to overcome, from understanding the fine print of your private student loans to tackling the challenges of adversary proceedings and the Brunner Test.

Finding an attorney who has the expertise to handle these complexities and is willing to help you through this process can be daunting. This is where I step in. As a student loan lawyer with extensive experience in helping borrowers from across the country, I have successfully guided numerous clients in using the bankruptcy process to alleviate burdensome private student loan debt — debt they once thought they would carry for life.

I invite you to take the first step towards a new financial beginning.

Schedule a consultation with my team and I. Together we can explore the best options for your situation. Remember, you don’t have to walk this path alone. Let us be your advocates and your guides in this journey toward financial freedom.

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