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Certain Private Student Loans May be Dischargeable in Bankruptcy

If you have student loans and struggle financially, you’ve probably thought that filing for bankruptcy wouldn't help you. Since when Congress wrote the law they made sure to specify what debts were and were not dischargeable.

The law seemed to protect all student loans from being discharged. However, what has been argued as a better interpretation of the law, opens up some private loans to be eligible for discharge in bankruptcy.  

Student loans were thought to be exempt from bankruptcy because courts were interpreting the law too broadly

The law states that there are certain exemptions to discharge, specifically:

  • Qualified education loans;
  • Obligations to repay funds received as an educational benefit; and
  • Federal loans.

These cannot be discharged in bankruptcy unless the borrower can show that repaying would “impose an undue hardship.”

What is "Undue Hardship"

Different courts have applied different standards for determining what qualifies as an undue hardship. No matter the standard applied, it is an increasingly difficult standard to meet. Accordingly, student loans are often considered to be impossible to discharge in bankruptcy.

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However, lawyers, doing what lawyers do best, argued, that the common interpretation of the exemptions is too broad. Attorney, Austin Smith, wrote an article about the misinterpretation of the bankruptcy law and student loans. To sum it up, courts were interpreting the law too broadly.

Congress had made a point of specifying in which situations debts could not be discharged in bankruptcy. So it must means some loans are dischargeable. Otherwise, there is no point in spelling out all of the exceptions.

Related: Why You Generally Can't Discharge Student Loan Debt in Bankruptcy

For example, let’s say the DMV decided that sedans and minivans were exempt from annual inspection, instead needing an inspection every two years. If the DMV meant all vehicles were exempt from annual inspection and now only required inspection every two years, why specify sedans and minivans? The answer is that some motor vehicles must still be required to get an annual inspection.

If Congress meant that all student loans are exempt from discharge, why spell out these three specific instances of exemption? The answer must be that not all student loans are exempt.

But those debts described, sound like student loans

At first glance, those exceptions may seem to be describing all student loans, but that is why lawyers are involved. It’s all about the details. Not all student loans are “qualified education loans.”

Additionally, “obligation to repay” is not the same thing as a loan. It could be a medical student accepted a scholarship on the condition they would be a doctor in a rural area after graduation. Instead, they went to be a doctor in the city, failing to meet the condition on which they borrowed the money. Meaning they are now obligated to repay.

Courts have started to accept this argument. Attorney Austin Smith successfully argued the law is interpreted too broadly and got a bar loan discharged in bankruptcy. The court concluded that the bar loan did not confer an “educational benefit” in the way Congress meant and that the bar loan was dischargeable in bankruptcy.

However, bar loans aren’t the only private loans that would qualify for discharge under the new interpretation of the law. As Attorney Smith explains in his article, any private loan that exceeds what is needed for the “cost of attendance” could also be dischargeable.

Private student loans that exceed the “cost of attendance” or were not for “educational benefit” may be dischargeable

The law states that only qualified education loans are protected from being discharged in bankruptcy. A qualified education loan is defined as loans that go towards the cost of attendance. The total cost of attendance includes paying tuition, books, and a reasonable allowance for room and board.

Federal loans will not be issued for an amount above the cost of attendance. For example, if you maxed out what you could borrow in federal loans and then took out private loans for more than the cost of attendance, those private loans could be dischargeable in bankruptcy proceedings.

Similarly, if the loan was more a consumer loan that was issued to you based on your creditworthiness rather than the fact that you were a student, an example being a bar loan, it may also be dischargeable.

If facing bankruptcy, ask your attorney about discharging private student loans and having federal loans classified differently

Since this argument is relatively new, your bankruptcy attorney may not be aware of it, so you should ask them to consider it when looking at your student loans.

If you also have federal loans, you can ask that for purposes of the bankruptcy proceedings they are classified differently. This will allow you to continue to qualify for Income-Driven Repayment plans and loan forgiveness programs.

No one wants to file for bankruptcy, but if you must, don’t give up hope on finding relief for your student loans. Federal student loans provide many repayment programs to make repayment manageable. And a select few attorneys are showing that some private student loans can are dischargeable in bankruptcy.

Related: What is Student Loan Forgiveness & How to Qualify

Money tools & resources i recommend

Chime (for saving) works by starting a spending account (takes 5 minutes) and opting into the automatic savings plan. (Learn more about getting started with Chime).  Every time I use the Chime Debit Card it rounds up my purchase to the nearest dollar and puts in in savings. Right now they also offer a double round-up bonus on those savings. All those withdrawals add up over time. Chime is free to use, with no monthly fees. With Chime, you end up saving money without having to think about it.

Qapital (for building savings & reaching money goals) Qapital can help you reach savings goals. Once you have the Qapital App installed and a bank account (or in my case three) connected you set up a goal or goals.  Then you set savings rules for each of your goals. For example, I have a round up to the nearest $2 rule, a guilty spending rule -when I buy Dominos. Qapital is free to useBonus, when you use my link you'll get $5 after your first savings.

Qoins (for debt repayment) When you sign up for Qoins, you connect your bank account and then spend as you normally would. Qoins will round up your purchases to the nearest dollar and put that change towards an extra debt payment. Learn more on How Qoins Can Help You Pay Off Debt Faster

SoFi (for refinancing) If you have private loans or your debt to income ratio allows, consider refinancing with a company like SoFi. Learn more about what it's like to refinance with Sofi. Refinancing my bar loan with SoFi ended up saving me over $1,000. Use my link to refinance your student loan and you'll get a $100 bonus.

Certain Private Student Loans May be Dischargeable in Bankruptcy

Liz

Liz is a blogger helping people with personal finance and working for themselves. She shares her own journey to debt freedom and helps graduates dealing with above average student loan debt on her site, Less Debt More Wine. She currently resides in NC after calling Massachusetts home for nearly a decade.

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