Today I have the pleasure of presenting a guest post from Andrew Rombach at LendEDU. Andrew and I first met when he reached out to tell me about LendEDU, a marketplace for private student loans, student loan refinancing, credit cards, and personal loans. It aims to educate consumers about debt and present them with the most affordable options that fit for their circumstances.
Today I am honored to have him writing about private student loans and their role in bankruptcy. My personal interest in this area is 2-fold:
- I live in a country where tertiary education was free up until 20 years ago. Since then its cost had skyrocketed and burdening millions of graduates with tens of thousands of £ worth of debt upon entering the workforce. As a result, I am fascinated to hear from someone in a country where education has long been commercialized.
- I have always been fascinated with the bankruptcy process and the role it plays in someone’s finance, especially its effect on personal debts.
Andrew was happy to combine the 2 topics together, which became a natural fit for us.
Without further ado, I’d like to present:
Private Student Loans In Bankruptcy
By Andrew Rombach from LendEDU
The first line of defense in financing one’s college education is often federal student loans from the federal government. However, a small shift has taken place in the student loan industry of the United States, which many American students are all too familiar with. The shift involves several lenders beginning to offer competitive private loans to eligible borrowers.
Private student loans can seem more beneficial to borrowers in some circumstances.
Some students cannot fully cover tuition due to limitations in federal aid and need additional funding.
While helpful in a pinch, they also pose some unique challenges:
- Students that initially finance education expenses or refinance federal student loans with a private lender may ultimately pay more.
- Interest rates on private student loans could be higher for borrowers with less than ideal credit histories, and there are far fewer remedies if a financial hardship makes it difficult to repay the balance on time.
- Another significant downside to private student loans is the reality that, even in dire straits from a financial perspective, borrowers do not have an easy option for discharging loans balances through bankruptcy.
This is clearly shown in a recent bankruptcy case where a woman who was on government assistance after an illness filed and tried to include her student loan debt of $7,800. Although the rest of her outstanding debts were wiped clean, she was unable to clear the student loans despite having no financial means to repay. These challenges can happen to anyone with student loans, making it particularly important to understand bankruptcy and private student loan debt.
Why Is It So Hard to Declare Bankruptcy?
The main reason private student loans create obstacles in bankruptcy proceedings revolves around a specific clause in the Bankruptcy Abuse Prevention and Consumer Protection Act, signed into law in 2005. Under this legislation, federal and private student loans are challenging in bankruptcy because there must be proof that repayment causes an undue hardship.
Proving undue hardship requires the borrower to pass a means test that includes:
- Proof of prolonged hardship
- An inability to meet basic standards of living
- Proof that good faith efforts have been made to pay off the debt
With federal student loans, proving all three prongs of the test is nearly impossible because opportunities exist for income-based repayment for nearly all borrowers.
However, private student loans do not provide for lower payment requirements. Unfortunately, private student loans are also not easily discharged in the bankruptcy process because borrowers may need to sue the lender as part of the bankruptcy. The lender likely has a vast legal team and more resources than an individual borrower, especially one who is facing difficult financial circumstances.
While the state of private student loans and bankruptcy may seem grim to borrowers considering their options, recent discussions on Capitol Hill have offered some promise. In 2018, the Trump administration sought out public comment on the evaluation process of undue hardship claims as it relates to private student loans and bankruptcy.
As it stands now, each court determines if the borrower has met the burden of proof, but a clear definition of hardship has not yet been established. If it is, the Department of Education and the current administration believe that this may encourage more student loan borrowers to pursue bankruptcy, under more lenient terms. This would be a significant change in the student loan market. Yet it is a potential change that could save thousands of struggling borrowers from experiencing financial turmoil.
What Can You Do Before Resorting to Bankruptcy?
Although wiping the slate clean through bankruptcy may seem like a rare but possible option for some student loan borrowers, it has a detrimental impact on one’s credit score and credit history.
- Bankruptcy can reduce your credit score and remain a mark on your credit report for years.
- This has a negative impact on your ability to take out loans or credit.
To avoid the challenges that come with bankruptcy, student loan borrowers should consider alternatives before resorting to bankruptcy for private loans.
Option 1: Contact lenders to understand your options
Some private student loan lenders are willing to work with borrowers who are proactive in their search for assistance, offering a deferment or forbearance on payments for an extended period.
While the balance and ultimate obligation to repay is not eliminated, borrowers may have the time they need to rebuild their financial footing and begin on-time payment again in the future.
Option 2: Refinancing with another private lender.
This potentially could lower your interest rate or offer an extended repayment term may also be an option for some borrowers. With a reduced monthly payment, the pressure placed on a borrower is also reduced, helping them afford the student loan over time.
Interested student borrowers can compare student loan refinancing offers online through companies such as Nerdwallet, LendEDU, and Student Loan Hero.
However, refinancing may not be an option if a default has already occurred on a private student loan. If this is the case, working with your current lender as well as coming up with a feasible debt repayment strategy based on your budget may be the best course of action.