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Can private student loans be discharged in bankruptcy?

January 23, 2018

Can private student loans be discharged in bankruptcy? Yes. But it's complicated. To get rid of them, you have to know whether the loan is a qualified education loan. And to know that, you need to know whether it was more than your qualified higher education expenses.

There’s a lot of misinformation out there. So I can understand if you’re still wondering “can private student loans be discharged in bankruptcy?” The simple answer is “Yes. And they can be discharged even without proving undue hardship.”

Can private student loans be discharged in bankruptcy

That answer, however, is, as I said, simple. There’s a lot more to it.

Before we get into that “a lot more”, let’s start with understanding what exactly is a student loan for bankruptcy purposes. This understanding is super important. Not every loan you took out while you were a student is a student loan for bankruptcy purposes.

Think about it. If you borrowed a pay day loan while you were a student, would that loan be a student loan for bankruptcy purposes? Or what about that credit card debt you racked up while you were a student? Or how about that loan you got to buy a laptop?

So what exactly is a student loan for bankruptcy purposes?

To answer that we need to look to the Bankruptcy Code. Specifically, we need to look at:

523a8 – Student loan bankruptcy exception

Section 523(a)(8) says that only certain types of education related debts are student loans for bankruptcy purposes. Those certain debts are:

  1. A loan made or insured by the government;
  2. A loan made under a program funded by the government or nonprofit;
  3. A conditional grant of money like a scholarship or stipend; and
  4. Finally, a debt that is a qualified education loan within the meaning of the Internal Revenue Code.

The first two types of debt address 523(a)(8)(A)(i). The third addresses 523(a)(8)(A)(ii). The last addresses 523(a)(8)(B).

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Do me a favor. Look closely at the debts I listed. Notice, each identifies a specific type of debt. For instance, the first two covers federal student loans. The third covers conditional scholarship programs like ROTC scholarships. And the fourth? It covers a private student loan that is a qualified education loan.

So given that explanation, here are the types of loans that are a student loan for bankruptcy purposes:

  • Federal student loans
  • Loans made under programs funded by a nonprofit (e.g., the St Louis Scholarship Foundation); and
  • Private student loans that are qualified education loans.

With that understanding, let’s return to the original question: Can private student loans be discharged in bankruptcy?

The answer, of course, is yes. You can get rid of a private student loan in bankruptcy — without proving undue hardship — if the private student loan is not a qualified education loan. That answer naturally leads us to ask:

What is a qualified education loan

Short answer: A qualified education loan is a loan you borrowed to pay your school expenses.

The long answer is more complicated and involves reading a bunch of different laws, starting with:

Section 221(d) of the Internal Revenue Code of 1986

Here’s the thing about section 221(d): to fully understand what a qualified education loan is, you have to define a bunch of different terms.

And to define those terms, you have to look into different sections of the IRC.

I’ve already wrote a deep dive into what exactly is a qualified education loan so I won’t repeat myself here. Instead, I’ll share with you how I analyze whether a private student loan is a qualified education loan.

My analysis consists of asking 3 questions:

  • Were you a taxpayer when you borrowed the loan?
  • Was the loan more than your cost of attendance at your college?
  • Did you college qualify for federal financial aid?

If the answer to any of these questions is no, then the private student loan isn’t a qualified education loan. And if it’s not a qualified education loan, then you can get rid of it without proving undue hardship.

Let’s quickly talk about these questions.

Who is a taxpayer?

The first question is pretty straight-forward. You must have been a taxpayer when you borrowed the loan for it to be a qualified education loan. The IRC says that a taxpayer is any person subject to an internal revenue tax.

What it means to be subject to an internal revenue tax, however, isn’t entirely clear. I’ve found only one student loan bankruptcy case that discusses this issue. In that case, the court said that you don’t become a taxpayer until you file a return.

Given that ruling, it’s arguable you had to have filed a tax return the year you borrowed the private student loan for that loan to be a qualified education loan. I don’t know if I agree with that interpretation. But…it’s a worth a shot.

The loan could not be more than your cost of attendance

Think of cost of attendance as the budget your school set for you each semester. For instance, for the fall and spring semesters your school said that it will cost you x in tuition, x in expenses, x in books, x in housing, x in food, etc. The total of all those x’s is your budget. In turn your budget is your cost of attendance. And, for qualified student loan purposes, your cost of attendance is your qualified higher education expenses.

Get it? Okay, maybe that’s a little complicated. Try this instead:

budget = cost of attendance = qualified higher education expenses.

So what does this have to do with private student loans?

For many of you, when your school set your budget/cost of attendance, it awarded you enough financial aid in the form of federal student loans and grants to cover your cost of attendance. Still, that didn’t stop you from borrowing that private student loan.

But here’s the thing about that loan. When you borrowed it, almost every dollar of that loan was more than your cost of attendance, which was already covered by financial aid. Because of that, you couldn’t have borrowed the private student loan solely to pay qualified higher education expenses. And because of that, the private student loan is not a student loan for bankruptcy purposes and should be dischargeable.

Your school had to be an eligible education institution

An eligible education institution is simply any college, university, or other post-high school institution that’s eligible for federal student aid. You can check to see if your school was an eligible education institution when you got your private student loan by visiting ifap.ed.gov.

In my experience, most of my clients attended an eligible education institution. The few who didn’t typically attended some type of helicoptor/flight school that has since closed its doors.

Can private student loans be discharged in bankruptcy

Let’s recap. We started by asking, “Can private student loans be discharged in bankruptcy?” To answer that question, we had to look at a few different laws and define a bunch of terms.

In the end, we came to see that, yes, a private student loan can be discharged in bankruptcy if one of 3 things is true:

  • You weren’t a taxpayer when you borrowed the loan
  • The loan exceeded your cost of attendance or
  • Your school wasn’t eligible for federal financial aid

Now what does all this mean for you?

Think about how you paid for school. If most are all of your school was paid for with federal student loans, grants, and scholarships, but you still borrowed private student loans, you may be able to get rid of your private student loans by filing bankruptcy.

Shoot me a text at 314-884-1886. Let’s talk about getting rid of your private student loans.

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