Can I discharge a private consolidation loan in bankruptcy?

If you consolidated your student loans into a private consolidation loan, you must meet the undue hardship test in order to wipe out the debt in bankruptcy.

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Question

I had several federal student loans and recently consolidated them into a private consolidation loan. I am still struggling to pay my student loans and other debts. If I file for bankruptcy, can I discharge the private consolidation loan?

Answer

Consolidation loans, where you refinance one or more student loans, are subject to the same rules in bankruptcy as regular student loans. This is true for both federal consolidation loans and private consolidation loans. You cannot wipe out these loans in bankruptcy unless you demonstrate to the court that to repay them would cause you undue hardship.

There is one possible exception, however. If your new consolidation loan includes debts other than student loans, it might be dischargeable without having to meet the undue hardship test.

What Is a Consolidation Loan?

Many student loan borrowers refinance their student loans in order to get a better interest rate or to get out of default. You can consolidate one or more loans into a federal Direct consolidation loan (there are a few restrictions as to the types of loans you can consolidate into this program), or you can consolidate using private financing. (Learn more about student loan consolidation, including who is eligible and the pros and cons of such loans.)

Treatment of Private Consolidation Loans in Bankruptcy

Student loans can be wiped out in bankruptcy only if you can demonstrate to the court that to repay them would cause undue hardship to you and your dependents. The undue hardship test is not an easy one to meet. Different courts use slightly different criteria. (To learn about the different factors courts review in determining undue hardship, visit our Student Loans and Bankruptcy topic area.)

The undue hardship test applies to both federal loans (those loans made or guaranteed by the federal government) and private student loans. This is a change from the past – prior to 2005, private student loans were dischargeable in bankruptcy without having to meet the undue hardship test.  A consolidation loan that simply replaces your previous student loans is considered to be a “qualified educational loan” that is subject to the student loan discharge rules.  (Learn more about private student loans in bankruptcy.)

Exception for Mixed Use Loans

There might be an exception if your consolidation loan paid off student loans and other types of debt not related to your education. These types of loans are called “mixed use loans,” and an argument can be made that they don’t fit within the definition of a “qualified educational loan.” This is because to be a qualified educational loan for purposes of bankruptcy, a refinanced loan must include debt incurred “solely to refinance a qualified educational loan.”

If you think your private consolidation loan is a mixed use loan, consult with a local bankruptcy attorney with experience in student loan issues to get advice.

Dangers of Private Consolidation Loans

If you get a private consolidation loan to pay off only student loan debt, you won’t receive any advantage in bankruptcy since you’ll have to meet the same discharge standard as that for federal loans and federal consolidation loans. But there are numerous pitfalls with private consolidation loans. For example, if you consolidate federal loans into a private loan, you won’t be eligible for the flexible repayment programs and other student loan debt relief options available for federal loans. If you want to consolidate your student loans, consider a federal Direct consolidation loan first.

by: , J.D.

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