When you file Chapter 7 bankruptcy, all collection activity stops until your case ends. When it does, the bankruptcy court will enter a discharge order that clears credit card debt, medical bills, repossessions, and other types of debts. But that order won’t affect your private student loan debt. You’ll still need to pay it back.
The only way Chapter 7 will eliminate your private student loans is if you start a second bankruptcy process known as an adversary proceeding. You’ll file a complaint asking the bankruptcy judge to wipe away your private loans in that action.
Keep reading to learn more about discharging private student loans in Chapter 7.
Struggling under the weight of your private loans? Settlement or student loan refinancing may be an option, depending on your finances. If you’d like help figuring out your options, schedule a call to speak with a student loan lawyer.
Can private student loans be included in Chapter 7?
Once you file a Chapter 7 bankruptcy case, all your debts, including your private student loans, will be put on hold. Your lenders won’t be able to collect from you until after the bankruptcy proceedings are over. The automatic stay on collections will also temporarily freeze student loan lawsuits* and pause wage garnishments, tax refund offset, and so on.
While the case is pending, your private and federal loans will be put into forbearance. Although you won’t need to make the monthly payments, interest will continue to accrue on your loan balance, which means you’ll leave bankruptcy owing more than what you started.
After the case ends, the court will enter a bankruptcy discharge order that wipes out most of your debts, but not your education loans. You’ll have to file an additional lawsuit known as an adversary proceeding to get a student loan discharge. If you paid a bankruptcy attorney to file Chapter 7, that fee wouldn't cover this process. You’ll need to hire them again, find a student loan bankruptcy lawyer, or file the lawsuit yourself.
* If your cosigner is being sued for student loans, the creditor can continue with the lawsuit and demand payment from them. Bankruptcy law doesn’t protect cosigners in Chapter 7. You’ll need to file Chapter 13 bankruptcy to protect your cosigner.
Private student loan debt can be discharged
There are two ways to discharge private student loans in bankruptcy:
- Show that repaying the loans would cause you and your dependents an undue hardship.
- Demonstrate that the loans aren’t student loans within the meaning of the U.S. Bankruptcy Code.
Meeting the undue hardship standard is challenging, mainly because it’s a concept not defined in the U.S. Bankruptcy Code. Instead, Congress left that to bankruptcy judges to interpret. To meet the standard, you must typically pass the “Brunner Test,” named for a court ruling from a 1980’s bankruptcy case in New York where a student attempted to discharge her federal loans less than a year after earning her master’s degree (she lost).
The Brunner Test requires you to prove three things:
- You can’t make your student loan payments and maintain a minimal standard of living.
- Your financial situation is likely to last throughout the repayment period.
- You made a good faith effort to repay the debts before filing bankruptcy — i.e., you made monthly payments, asked for deferments and forbearances, tried to refinance, and so on.
Private student loan borrowers often find it easier to pass the Brunner Test than borrowers with federal student loans. Unlike the Department of Education, private lenders don’t offer income-driven repayment plans and student loan forgiveness options. It’s hard to say your hardship is undue when you have an affordable monthly payment and the government will cancel your debt after 20 - 25 years of student loan repayment. Read more about income-driven repayment forgiveness.
Learn More: What is Undue Hardship on Student Loans?
Not a student loan
In the past few years, federal courts across the country have recognized that some private student loans can be discharged without proving undue hardship. Bankruptcy law* would protect loans from private lenders only if the money was used to cover the student’s cost of attendance at an eligible school. If the bank lent you more than you needed to pay for tuition, books, housing, and so on, then the debt isn’t a student loan, as defined in the Bankruptcy Code.**
This practice — letting students borrow more than they need to pay for school — was common until the 2010s. Companies like Sallie Mae, Navient, National Collegiate Student Loan Trust, and so forth still hold millions of dollars of these types of debts.
** To get a discharge, you may still need to prove that the private loan isn’t an educational benefit, scholarship, or stipend or that the loan wasn’t made under a program funded by a nonprofit. See 11 U.S.C. 523(a)(8)(A).
How to file for Chapter 7 bankruptcy?
To qualify for Chapter 7 bankruptcy you:
- Must pass the means test, which considers your income, assets, and expenses.
- Cannot have completed a Chapter 7 bankruptcy in the past eight years or a Chapter 13 bankruptcy in the past six years.
- Must not have filed for bankruptcy in the last 180 days and had the case dismissed because you failed to appear in court, ignored the court’s orders, or voluntarily dismissed the case because a creditor tried to collect property it had a lien on.
Fixing your finances after bankruptcy
Your credit score will take a hit when you file bankruptcy, but getting rid of high-interest rate private student loans gives you a good starting point. Here are two steps to take after bankruptcy:
- Build better financial habits. Create a budget, set financial goals, and speak with a money coach to help you along the way.
- Fix your credit. A few months after your case ends, check your credit reports to make sure it’s accurate. Dispute mistakes. Also, although the bankruptcy filing will stay on your credit report for several years, your score should bounce back within two years if you get new credit cards, keep your balances low, and pay your bills on time.
Filing bankruptcy to deal with private student loan debt can be an effective strategy. But before you rush to court, speak with a lawyer experienced in using bankruptcy to discharge private and federal loans.
Since 2014, I’ve helped dozens of borrowers across the United States use bankruptcy to tackle their education loans.
Schedule a free 10-minute call with me today. We’ll work together to determine the best strategy to deal with your student loans inside and outside bankruptcy.