The following article is a summary prepared by the authors of various articles about bankruptcy. It is not intended as, and should not be read as, legal advice. If you feel you need to consider bankruptcy, you should contact an attorney in your area who is qualified to lead you through this complex and weighty decision. You should not rely on this article or any Internet article to guide your decision.
Contrary to conventional wisdom, a private student loan, much like a federal student loan, is dischargeable under the right circumstances and has been since 2005. Popular thought may lead you to believe that filing bankruptcy on your private student loans is hopeless, but that’s not exactly true.
If you can’t repay your student loans, or you do not qualify for public service loan forgiveness (PSLF) or flexible student loan repayment plans, such as an income driven repayment plan, extended repayment plan, or Pay As You Earn Repayment Plan (PAYE), then bankruptcy may be an option to consider. This is especially true for borrowers who take loans out after July 1, 2019, as Congress looks to end PSFL and other repayment programs.
But while it is possible to discharge private student loans in bankruptcy, there are major consequences to your credit score. With 20 years of experience, Credit.com uses financial expertise to help you rebuild your credit and bounce back from bankruptcy. We’ve outlined the process and criteria for discharging your private student loans, as well as how you can save your credit through specialized services, like credit monitoring and personalized consultations.
As a student, you can also take advantage of credit cards intended just for students to begin building your credit and earning rewards. Check out Credit.com’s expert guide to the best credit cards for students to earn cash back and save on things like books, dining, entertainment, and even electronics.
How Will Student Loan Bankruptcy Affect My Credit Score?
Unfortunately, student loan bankruptcy will ultimately carry with it some serious consequences, and will likely negatively affect your credit score. Even if bankruptcy seems like the best choice for you right now, you should still heavily consider the long-term repercussions that will impact your credit over the next several years. In the case of a Chapter 7 bankruptcy, it takes only about 90 days to forgive the debt tax-free. While the process may seem like it’s over, there is still more work to do to make up for the impending hit to your credit score.
Building credit, especially for younger borrowers, is not easy when bad credit gets in the way of owning a credit card. You can find secured credit cards with lower annual fees and payment alerts. You are less likely to be denied a secured credit card than a standard credit card, so repairing your credit doesn’t feel like an impossible goal.
What Is a Qualified Education Loan?
Student loans are protected against bankruptcy by law unless eligibility is proven otherwise. However, many loans can be referred to as student loans without meeting the right requirements. According to bankruptcy attorney Craig Andresen, in order for a loan to be qualified as a student loan:
“(1) it must have been made under a government or nonprofit student loan program, or (2) it must be a qualified educational loan under section 221(d)(1) of the Internal Revenue Code, for attending an eligible education institution as defined in section 221(d)(2) of the Internal Revenue Code, and incurred for costs of attendance as defined in section 472 of the Higher Education Act.”
Andresen says, “Perhaps you were not an ‘eligible student’ at the time the private student loan was made to you; or maybe the loan was not incurred to pay ‘qualified education expenses’; or perhaps the loan was not for attendance at an ‘eligible education institution’ because the school was not accredited under Title IV of the Higher Education Act. All these are requirements imposed by section 221(d) of the Internal Revenue Code. Failure of a private student loan to meet any of these criteria means that the loan is fully dischargeable, because it would not qualify under section 523(a)(8) of the bankruptcy law.”
Still searching for the right student loan? It’s important to know the details of your private student loan in the event of a financial rough patch. Taking out large, private loans may not always be the best first option, especially if you have poor or non-existent credit. However, if a private student loan is still necessary, you can be matched with an appropriate loan for your credit score and financial situation through Credit.com.
What Schools Qualify as Eligible Education Institutions?
If you owe private student loans for a school that was not accredited, your loans can probably be discharged in a Chapter 7 bankruptcy right away. Even some big-time lenders still make private student loans to such unprotected organizations. It’s quite common to find vocational and trade school students with these types of unprotected loans. Flight schools for pilots seem to be notoriously unaccredited, yet pilots errantly labor under hundreds of thousands of dollars of unmanageable student loans believing there is no hope for them. You can see some real case studies showing how easily these loans were discharged.
In particular the issue that makes these private student loans so easily dischargeable in bankruptcy is the fact the school was not an “eligible educational institution” or that the loans were for a “qualified higher education expense.”
The characteristics of a private student loan get even more specific. An accredited school must also have offered Title IV federal loans or the private loans may not be protected from discharge in bankruptcy.
Expert Tip: But wait! Just because your school met all the requirements of a Title IV of the Higher Education Act of 1965 doesn’t mean some or all of your private student loans are not eligible to be eliminated in bankruptcy. If your loans were used for things other than a “qualified higher education expense,” the law does not protect those amounts. If you used your private student loan money for things other than tuition, books, supplies, and required equipment, that part of your student loans may be eliminated in bankruptcy today.
Do Your Private Student Loans Fall Under the Statute of Limitations?
If your private student loans are still protected, there is still some good news. All private student loans are no longer legally collectible once they have expired under the statute of limitations in your state. Unlike federal student loans that have no statute of limitations, private student loans are not guaranteed by the government and can fall under the rules of each state. In that case, while they may be listed as a debt on your bankruptcy filing, there isn’t much of a need since the lender can no longer sue you or garnish your wages over those debts. In some states, the statute of limitations is as little as three years. In others, it is 15 years.
As of June 30, 2010, federal student loans are no longer guaranteed by the federal government, though they are made directly. All loans taken out before this date are still considered federal student loans and do not fall under the same statute of limitation rules as private student loans.
Claiming Undue Hardship in a Student Loan Bankruptcy Case
A Chapter 7 bankruptcy alone will not wipe away your student loan debt. In order to stop collections altogether, you will have to file a petition for a determination of undue hardship. Claiming undue hardship means that repaying your loan is too difficult and too expensive — like a weight that moves the scale from “struggling” to “suffering.” This determination will take place in an adversary proceeding in bankruptcy court.
There are three criteria you must meet to successfully claim undue hardship in a student loan bankruptcy case:
- Proof that repaying the loan means you will not achieve a minimal standard of living
- Evidence to prove that hardship will continue throughout the loan repayment period
- Proof that you made a true effort to repay the student loan before filing bankruptcy
This three-step measurement is also known as the “Brunner Test,” and if all requirements are met, your lender will no longer be able to collect loan payments from you.
So, what circumstances are likely to prove undue hardship? Serious health concerns or permanent disability can indicate that the student loan borrower can’t work to make repayments. In addition to health, a poor financial situation can be enough to sway the decision. Repayments can cause significant financial strains for single mothers or individuals whose dependents can’t live on the current family income. Or, you may be able to prove that you have hit maximum earning capacity at a wage that is too low to sustain a minimal standard of living.
If the determination of undue hardship is unsuccessful, you can still apply for Chapter 13 bankruptcy, which allows the court, rather than the lender, to determine the monthly size of repayments. These payments will often be smaller and allow for more flexibility for several years until repayments return back to normal or the borrower petitions once again for undue hardship.
Student loan bankruptcy does not have to permanently damage your credit. If you are filing for private student loan bankruptcy or your student loans have been discharged, start by signing up today for a free credit report. Credit.com also offers free Experian credit scores, credit reports, and expert advice that can help you create an action plan to rebuild your credit.
More on Managing Debt:
- The Credit.com Debt Management Learning Center
- Understanding Your Debt Collection Rights
- Top 10 Debt Collection Rights
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