Bankruptcy provides protection from your creditors when you cannot pay your debts. But forgiving a private student loan in the event of bankruptcy can be a difficult and often impossible process. Read on to learn how the process works now and how recent court cases and pending legislation in Congress may give weary student borrowers more solutions in the future.
Can you discharge private student loans in bankruptcy?
Prior to 1976, borrowers could pay off private and federal student loans in bankruptcy, just like credit card debt or medical expenses. But the introduction of US bankruptcy law in 1978 caused a major shift in terms of student debt.
At the time, Congress’ intent was to protect educational loans from bankruptcy abuse. The amended Bankruptcy Code stipulated that money received as educational benefits would no longer be disbursed unless the borrower could demonstrate undue hardship.
Since the ability to pay off private student loans has become limited, there has been a lot of controversy surrounding this topic. In recent years, there have been a number of major court rulings that have made it possible to release private student loans. However, lawyers caution that these provisions still don’t necessarily mean that all private student loans are non-chargeable in bankruptcy — at least not without special circumstances.
It seems as if the courts will eventually answer that question, unless Congress takes preliminary action. However, until that happens, the bankruptcy law allows private student loans to be discharged in bankruptcy only if the borrowers can meet the standard of unexplained hardship.
How to file for bankruptcy with student loans
Before you can proceed with seeking to cancel any private student debt through forgiveness, you will first need to file for Chapter 7 or Chapter 13 bankruptcy. If you are considering this approach, it is likely that you have defaulted and are unable to meet your financial obligations. Lenders and creditors may already have sought provisions or handed over accounts to debt collectors.
Once you begin the bankruptcy proceedings, you will need to file a deduction suit, which is similar to a lawsuit in other courts. As a plaintiff, you can seek certain types of debt relief, such as private student loan forgiveness, through these discount procedures.
During this deduction procedure, you will need to prove that you meet the strict criteria of the Unexplained Hardship Clause. This is an essential step if you want the court to cash your student loan balance.
Prove undue hardship
Excessive suffering, sometimes called “desperation despair,” has historically been difficult to prove. To prove undue hardship, you need to meet three criteria:
- If you have to repay the loan, you will not be able to maintain the minimum standard of living.
- There is evidence that this hardship will persist for a large part of the loan repayment period.
- You made a good faith effort to pay off the loan before filing for bankruptcy.
To prove undue hardship, you will need to gather as much evidence as possible. Document all monthly expenses, loan statements, and communications with your lender, as well as any other evidence of financial burdens, such as medical bills or a job termination notice.
Latest news about student loan bankruptcy
In the past, it was difficult to obtain a private student loan discharge in bankruptcy, but several recent lawsuits have demonstrated the possibility.
One notable case reached the US Court of Appeals for the Second Circuit of the US Bankruptcy Court for the Eastern District of New York. In the original case, U.S. Bankruptcy Judge Elizabeth Strong concluded that private student loans were not part of the Section 523(a)(8)(a)(2) bankruptcy code, which states that any “obligation to repay money received as an educational benefit or Scholarship or stipend” usually does not qualify for a layoff.
She emphasized that the code section did not specify student loans or educational benefits, and that referring to the loan as an educational benefit would be an “unconventional way to discuss the loan.” The Court of Appeals upheld the lower court’s ruling, arguing that US bankruptcy law does not prohibit the discharge of a private student loan in bankruptcy.
Some see the Second Circuit’s decision as a hope of relaxing the standards in private student loan bankruptcy. However, in June 2021, the US Supreme Court refused to hear the case of a Texas woman who sought forgiveness from her private student loans according to different criteria – so it appears that the undue hardship clause may still apply.
The courts seem divided on the issue of laying off private student loans at the moment. Meanwhile, US senators and representatives are seeking to make it easier for federal and private student borrowers to repay those debts during bankruptcy. Senators Dick Durbin and John Cornyn introduced a bipartisan bill proposing that student distressed borrowers should have the opportunity to pay off student loans in the event of bankruptcy after a 10-year waiting period.
There is movement in the House of Representatives on the student loan bankruptcy front, too. Democratic Congressmen Steve Cohen, Danny K. Davis and Eric Swalwell introduced the Private Student Loan Bankruptcy Equity Act, which would allow private student loans to be issued during the bankruptcy process.
If you find it difficult to pay off private student loans, it may be possible to forgive them. However, you and your bankruptcy attorney may face a difficult legal battle to try to make this happen, as the courts have not yet settled on the issue of repaying your private student loan through bankruptcy.
Unless (or even) Congress takes action to forgive this type of debt, you may be better off looking for other alternatives. If you can’t get a discharge on your student loans, consider contacting your lender to see if you can work on a debt settlement or debt repayment program. You can also speak with a reputable debt settlement attorney for professional advice.