Private student loans can now be discharged in bankruptcy, but consider alternatives first


In July 2021, a federal court ruled that private student loans could be discharged in bankruptcy. But refinancing a student loan may offer a better way to manage your college debt without significantly damaging your credit score. (iStock)

Bankruptcy is a legal process that offers financial relief to consumers who cannot repay their debt. Many types of debt can be written off in bankruptcy, including credit card debt and medical debt. But some types of educational benefits, like federal student loans, cannot be discharged in bankruptcy.

In previous bankruptcy cases, it was not clear whether private student loans were dischargeable – until July 2021, when a federal court ruled that private student loans are not considered expenses of higher education qualified under the United States Bankruptcy Code.

Canceling private loans in bankruptcy can provide much needed respite for debtors who cannot honor their debts, but bankruptcy has a lasting impact on a person’s finances and credit rating. It is important to consider the alternatives before resorting to bankruptcy.

If you’re having trouble making your private student loan payment, refinancing may be the answer. By refinancing your college debt at a lower rate, it may be possible to lower your monthly payment to avoid defaulting on your loans.

Private student loan refinancing rates are hovering near historic lows. To lock in your interest rate, get pre-approved for your student loan refinancing on Credible.


Private student loans can be canceled in bankruptcy, Federal Court judges

The Bankruptcy Code prohibits the discharge of certain types of debts in bankruptcy proceedings, in particular debts incurred as part of an “educational service”. But private student loans do not fall into this category, according to a July 2020 court ruling.

A New York-based federal bankruptcy appeals court has ruled in favor of a debtor whose private student loans issued by Navient have been released from bankruptcy. The ruling further defines the meaning of an “educational benefit”, setting a precedent for private loan holders who wish to pay off their student loan debt in the future.

For example, a “scholarship” for a student-athlete does not need to be reimbursed if the recipient remains on the team; similarly, an “allowance” is a payment which is conditional on the provision of services by the recipient and generally does not need to be reimbursed. The defining characteristic of a loan, on the other hand, is the unconditional obligation to repay it.
“Education allowance” should therefore be interpreted as referring to conditional grant payments similar to scholarships and stipends.

– July 2021 United States Court of Appeals Decision for the Second Circuit

But just because it may be legal to pay off those debts in bankruptcy does not mean it is advisable. You should weigh the implications of this drastic debt relief measure and consider alternatives, such as refinancing.


Refinancing a Private Student Loan May Offer a More Favorable Alternative to Bankruptcy

Chapter 7 bankruptcy, also known as run-off bankruptcy, essentially allows you to write off your private student loan debt, but it comes with a few major drawbacks:

  • You are usually required to liquidate luxury assets, such as a vacation home or second car, as well as financial assets such as savings, stocks, or other investments.
  • This will take a big hit on your credit score, making it more difficult to approve low-interest financial products.
  • You may earn too much money to file for Chapter 7, depending on your household income and a bankruptcy means test.
  • You may need to hire a bankruptcy attorney, and attorney fees can increase the initial cost of filing for bankruptcy.

Bankruptcy will stay on your credit report for 10 years, and it will have an immediate negative impact on your credit score. With bad credit, you will receive lower deals on financial products like mortgages, auto loans, and credit cards, if you can qualify under those circumstances.

On the other hand, refinancing a private student loan can offer a way to make your college debt more manageable without leaving a damaging mark on your credit history. Private student loan refinancing rates are near historic lows, which means you may be able to get a better interest rate on your debt and lower your monthly payment. As part of a more affordable repayment plan, you may be able to keep your finances afloat without defaulting on your loans.

You can browse your estimated interest rates without a credit check on Credible to determine if refinancing can help you stay up to date on your private student loan debt.


How to Decide If Refinancing a Student Loan Can Help You Avoid Bankruptcy

It can be difficult to budget for private student loan repayments, especially during times of financial difficulty. Bankruptcy is one way to deal with unmanageable debt, but it’s not your only option. You may be able to reduce your monthly payment by $ 250 or more by refinancing your private student loan debt over a longer repayment period, according to data from Credible.

It is easy to see how much you can save on your monthly loan payments through refinancing. First, make sure you have private student loans, as federal student loan refinancing makes you ineligible for protections such as postponement of undue hardship and cancellation of qualified student loans. Then follow these steps:

  1. Gather your current student loan documents to find your interest rate and loan amount.
  2. Get prequalified to see your new estimated interest rate.
  3. Enter your loan information into a student loan calculator to determine your monthly payment.

Once you have an idea of ​​your new monthly student loan payment, you can decide if the difference is large enough to prevent you from defaulting.

You can compare the estimated rates of several refinance lenders at once on Credible without affecting your credit score, so you have nothing to lose. Make an informed decision about your current financial situation by exhausting all of your options before considering bankruptcy.


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