Private student loans can now be repaid in the event of bankruptcy, but consider alternatives first



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

Bankruptcy is a litigation that provides financial assistance to consumers who are unable to pay their debt. Many types of debts can be forgiven in bankruptcy, including credit card debt and medical debt. But some types of educational benefits, such as federal student loans, cannot be relieved of liability in bankruptcy

In previous bankruptcy cases, it was unclear if private student loans were repayable – until July 2021, when federal court ruled that private student loans do not count as spending on qualified tertiary education in accordance with United States Bankruptcy Code

Granting private loans in the event of bankruptcy can provide much-needed respite for debtors who cannot meet their debt obligations, but bankruptcy has a lasting impact on a person’s finances and credit rating. Before resorting to bankruptcy, it is important to consider alternatives.

If you are having trouble paying off your private student loan, refinancing may be the answer. By refinancing your college debt at a lower rate, you can reduce your monthly payment to avoid default on your loans.

Refinancing rates for private student loans are hovering near historic lows. To fix the interest rate, get pre-approval for student loan refinancing on Credible.


Private student loans can be forgiven in case of bankruptcy under federal court rules

The bankruptcy code prohibits the repayment of certain types of debts through bankruptcy proceedings, including debts arising from “educational benefits.” But private student loans don’t fall into this category, according to a July 2020 court order.

The New York Federal Bankruptcy Court of Appeals ruled in favor of the debtor whose private student loans issued by Navient were declared bankrupt. The ordinance also defines the meaning of an “educational benefit”, setting a precedent for private loan holders looking to pay off student loan debt in the future.

For example, a student athlete’s “scholarship” does not need to be refunded if the recipient remains on the team; similarly, a “scholarship” is a payment that is conditional on the performance of services by the recipient and is generally non-refundable. In contrast, the defining characteristic of a loan is an unconditional obligation to pay it back.
Thus, “education grant” is best understood as a conditional grant payment, similar to scholarships and fellowships.

– Judgment of the US Court of Appeals for the Second Circuit of July 2021

But the fact that paying off these debts in bankruptcy may be legal does not mean that 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 Be a Better Alternative to Bankruptcy

Chapter 7 bankruptcy, also known as bankruptcy liquidation, essentially allows you to write off your private student loan debt, but it has several major drawbacks:

  • Usually, you are forced to liquidate luxury assets such as a vacation home or second car, as well as financial assets such as savings, stocks, or other investments.
  • Your credit rating will be hit hard, making it difficult to obtain approval for low interest rate financial products.
  • You may make too much money to apply for Chapter 7, depending on your household income and bankruptcy test results.
  • You may need to hire a bankruptcy attorney, and attorney fees can add to the initial cost of filing for bankruptcy.

Bankruptcy will stay on your credit report for 10 yearsand this will have an immediate negative impact on your credit rating. With bad credit, you will get less lucrative deals on financial products like mortgages, car loans, and credit cards – if you can qualify for them at all under the circumstances.

On the other hand, refinancing a private student loan may offer a way to make your college debt more manageable without leaving a damaging mark on your credit history. Refinancing rates for private student loans are close to historic lows, which means you can get a higher interest rate on your debt and lower your monthly payment. With a more affordable repayment plan, you can keep your finances afloat without breaking your loans.

You can review your estimated interest rates without a hard credit request to Credible to determine if refinancing can help you stay on top of your private student loan debt.


How to decide if a student loan refi will help prevent bankruptcy

It can be difficult to budget for private student loan payments, especially in times of financial difficulty. Bankruptcy is one way to deal with unmanageable debt, but it is not the only option. You can cut your monthly payment by $ 250 or more by refinancing private student loan debt for a longer repayment period, according to Credible.

It is easy to see how much you can save on your monthly loan payment through refinancing. First, make sure you have private student loans, as refinancing federal student loans deprives you of protections such as unnecessary hardship deferral and qualified education loan forgiveness. Then follow these steps:

  1. Collect paperwork for your current student loans to find out your interest rate and loan amount.
  2. Prequalify to see the new calculated interest rate.
  3. Enter your loan information in student loan calculator to determine the monthly payment.

Once you get an idea of ​​your new monthly student loan payment, you can decide if the difference is significant enough to avoid default.

You can compare settlement rates across multiple refinancing lenders directly to Credible without affecting your credit score, so you have nothing to lose. Make an informed decision about your current financial position by exhausting all options before considering bankruptcy.


Have a financial question but don’t know who to contact? Write to a safe money expert and your question can be answered by Credible in our Money Expert column.


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