Private student loan bankruptcy: Everything you need to know
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Bankruptcy offers protection from your creditors when you can’t afford to repay your debts. But discharging a private student loan in bankruptcy can be a tall order. Read on to learn how the process works now and how recent court cases and pending legislation in Congress might give overwhelmed student borrowers more solutions in the future.
Can private student loans be discharged in bankruptcy?
Before 1976, borrowers could discharge private and federal student loans in a bankruptcy, just like credit card debt or medical debt. But the introduction of the U.S. Bankruptcy Code in 1978 caused a major shift with regard to student debt.
At the time, the intent of Congress was to protect educational loans from bankruptcy abuse. The amended bankruptcy code stated that funds received as an educational benefit would no longer be discharged unless the borrower could demonstrate undue hardship, which is no easy feat. To prove undue hardship, borrowers must demonstrate that paying back their loans would prevent them from maintaining a minimal standard of living and that their circumstances won’t be changing anytime soon.
Since the ability to discharge private student loans became limited, there’s been much debate on the subject. In recent years, there have been a number of major court rulings that made it possible to discharge private student loans. Yet attorneys caution that those rulings still don’t necessarily mean that all private student loans are dischargeable in bankruptcy — at least not without special circumstances.
It appears as though the courts will eventually answer this question, unless Congress acts first. However, until that happens, the bankruptcy code allows for private student loans to be discharged in bankruptcy only if borrowers can meet the undue hardship standard.
How to get your student loans discharged through bankruptcy
Before you can proceed with seeking the cancellation of any private student debt through discharge, you would first need to file for Chapter 7 or Chapter 13 bankruptcy. If you’re considering this approach, you’ve likely fallen behind on payments and been unable to meet your financial obligations. Lenders and creditors might have already sought judgments or turned over accounts to debt collectors.
Once the bankruptcy proceedings begin, you’ll need to file for an adversary proceeding, which is similar to a lawsuit in other courts. As a plaintiff, you can seek certain kinds of debt relief, like relief from private student loans, through these adversary proceedings.
During this adversary proceeding, you’ll need to demonstrate that you meet the strict standards of the undue hardship provision. This is an essential step if you want the court to discharge your private student loan balance.
How to prove undue hardship for student loans
Historically, it has been difficult to prove undue hardship, sometimes called a “certainty of hopelessness.” To prove undue hardship, you need to satisfy three criteria:
- If you are forced to repay the loan, you would not be able to maintain a minimal standard of living.
- There is evidence that this hardship will continue for a significant portion of the loan repayment period.
- You made good faith efforts to repay the loan before filing bankruptcy.
To prove undue hardship, you’ll need to gather as much evidence as you can. Document all of your monthly expenses, loan statements and communications with your lender, as well as any other proof of financial burdens, such as medical bills or a job termination notice.
Can you file bankruptcy on student loans in collections?
If you have private student loans in collections, you could get them discharged through a Chapter 7 bankruptcy. However, you will still need to file an adversary proceeding and prove undue hardship to get them discharged.
The latest news about student loan bankruptcy
In the past it has been difficult to get a private student loan discharge in bankruptcy, but several recent court cases have proved that it is possible.
One notable case came to the U.S. Court of Appeals for the 2nd Circuit from the U.S. Bankruptcy Court for the Eastern District of New York. In the original case, U.S. Bankruptcy Judge Elizabeth S. Stong concluded that private student loans were not part of the Bankruptcy Code Section 523(a)(8)(A)(ii), which states that any “obligation to repay funds received as an educational benefit, scholarship or stipend” is typically not eligible for discharge.
She maintained that the section of code did not define student loans or educational benefit, and that referring to a loan as an educational benefit would be “an unconventional way to discuss a loan.” The appeals court affirmed the lower court’s ruling, arguing the U.S. Bankruptcy Code did not prohibit the discharge of a private student loan in bankruptcy.
Some see the 2nd Circuit decision as hope for a loosening of the criteria in private student loan bankruptcy discharge. However, in June 2021, the U.S. Supreme Court refused to hear the case of a Texas woman who sought to have her private student loans discharged under a different standard — so it appears that the undue hardship requirement may still be in effect.
The courts seem to be divided on the issue of private student loan discharge for now. Meanwhile, U.S. senators and representatives are seeking to make it easier for federal and private student loan borrowers to discharge those debts during bankruptcy.
Back in September 2022, U.S. Elizabeth Warren and House Judiciary Committee Chairman Jerrold Nadler, reintroduced the Consumer Bankruptcy Reform Act. The bill, which was originally introduced in 2020, intends to replace Chapter 7 and Chapter 13 bankruptcies with a streamlined process. This new process will not only make it easier for all borrowers to file for bankruptcy but will also allow them to include their student loans as part of the list of dischargeable debts.
“We applaud Senator Warren’s and Chairman Nadler’s introduction of the Consumer Bankruptcy Reform Act, which would provide a more straightforward path for economically distressed Americans to move forward,” Mervyn Jones, senior director of External Affairs at Young Invincibles, said in a statement. “In particular, the bill’s provision to make student loan debt dischargeable would be a much-needed change in law to help struggling student borrowers. This bill’s focus on racial and gender disparities in the bankruptcy system would also foster greater equity and strengthen the strained social safety net.”
Should you file for bankruptcy just to get your private student loans discharged?
Filing for bankruptcy is something that shouldn’t be taken lightly. Not only will it affect your credit score and stay on your report for up to 10 years, but it can also impact your ability to access credit in the future. Lenders will see you as a potential risk, and you could get you denied for a mortgage or other credit products. It can also impact your ability to secure the best terms and interest rates available, making your debt more expensive.
Derek Brainard, national director of Financial Education at the AccessLex Institute, says that filing an adversary procedure to get your student loans discharged can also make your bankruptcy bill more expensive, as your lawyer will have to fight tooth and nail and provide extensive evidence to get the job done — and success is not guaranteed.
“While there is current legislative movement toward re-visiting the standards for including student loans in bankruptcy, recent rulings that appear to relax the criteria of the Bankruptcy Code for private student loan discharge should be viewed case-by-case, and not seen as guarantees by borrowers that their student loans can be successfully discharged,” Brainard says. “Until Congress or the courts dictate a wholesale change to the Code, borrowers need to move forward assuming the undue hardship standard stands. Because of the long-lasting impact of bankruptcy on a person’s financial wellness, other alternatives like debt settlement can be explored before committing to this path.”
The bottom line
If you find it difficult to repay your private student loans, it might be possible to have them discharged. However, you and your bankruptcy attorney could face a tough legal battle to try to make that happen, as the courts are not yet settled on the matter of private student loan discharge through bankruptcy.
Unless (or until) Congress acts to provide relief for this kind of debt, you may be better off seeking other alternatives. If you can’t get a discharge for your student loans, consider approaching your lender to see if you can work out a settlement or debt repayment program. You might also speak with a reputable debt settlement attorney for professional advice.