What Happens to Private Student Loans in Bankruptcy?

The federal bankruptcy laws preclude most student loans from being discharged. When an individual qualifies for a Chapter 7 proceeding, they are allowed to have most of their unsecured debts wiped out through bankruptcy. Some judges will allow a student loan to be discharged if the person can prove that paying back the loan would present them with an undue hardship. In April 2010, lawmakers in both the U.S. House of Representatives and the United States Senate introduced bills to allow borrowers to expunge their private student loans bankruptcy as an option. If the legislation is passed, those struggling with paying back private student loans will be allowed to discharge these debts due to unforeseen financial circumstances.

Private Student Loans vs. Federal Loans

The U.S. bankruptcy laws group both private student loans and federal loans into the same category of education loans, making them exempt from discharge through bankruptcy. In order to have a student loan erased, the borrower must be able to prove to the bankruptcy court that repaying the loan would result in an undue hardship to the individual. Some lawmakers feel that this is unfair when federal bankruptcy laws allow individuals to wipe out tax bills, gambling debts, criminal fines and even home mortgages.

In 2005, a bankruptcy reform bill signed by President George W. Bush added a provision recategorizing private student loans, which granted private student loan lenders protection against debt write-offs in bankruptcy; the same provision afforded to those providing federal student loans. New legislation is primarily aimed as restoring fairness in treating privately held student loans to the same ways that other private debts are treated during bankruptcy proceedings.

Private student loan borrowers remain at the mercy of the lender when facing financial stress due to unemployment, medical illness or disability. Because private loans lack consumer protections as those guaranteed by federal student loans, this presents an unfair advantage. Struggling borrowers are not afforded fixed interest rates. Often times their loans are turned over to collection agencies even when private lenders knowingly give loans to students who are likely to default on their payments.

Bankruptcy Lawyers Can Help Your Case

The Fairness of Struggling Students Act proposed by legislators would allow student to discharge their debts through bankruptcy. Democratic lawmakers are in favor of this, allowing private student loans to be discharged in bankruptcy. Individuals who are having trouble meeting their financial obligations due to large amounts of student loans can be best served by consulting a bankruptcy attorney to review their circumstances and offer advice of what may best serve their needs.