Private Student Loans in Bankruptcy

Wiping out private label student loans in Chapter 7 or Chapter 13 bankruptcy is difficult.

If you have a private label student loan, it is very difficult, but not impossible, to discharge it (wipe it out) in Chapter 7 or Chapter 13 bankruptcy. To do so, you must bring a separate action in the bankruptcy court and prove that repaying the loan would cause you “undue hardship” -- currently a tough standard to meet.

Read on to learn more about private label student loans, the undue hardship standard, and how Chapter 13 bankruptcy can help temporarily reduce your payments.

(For more articles, visit our Student Loans in Bankruptcy topic area.)

What Are Private Label Student Loans?

Many student loans are either guaranteed by the federal government or made directly by the federal government. (As of June 30, 2010, the federal government no longer guarantees loans, it just makes them directly. But there are lots of federally guaranteed loans still kicking around.) Some of these loans may sound familiar to you, such as Stafford Loans, Direct Loans, and PLUS Loans.

But banks and other private financial institutions also offer loans to students. These are called private student loans or private label student loans. As the cost of higher education rises, many students find that they cannot fund their entire education with federal loans only and many must use private label loans as well. And private label lenders often target students going to vocational schools (like auto mechanic schools) and professional schools (like chiropractor programs).

Currently, 15% of all student loans are private label loans.  According to the National Consumer Law Center, over 85,000 private student loans are in default.

Private Label Student Loans in Bankruptcy

Prior to 2005, private label student loans were treated like other unsecured debt in bankruptcy, and were essentially discharged at the end of the bankruptcy case.

However, in 2005, Congress changed the status of private label loans in bankruptcy to match that of federal loans. This means that now, in order to discharge a private label student loan, you must show that repaying the loan would cause undue hardship.

Questionable Policy Behind the Law Change?

Many consumer advocates argue that Congress was misguided in changing the law to treat private student loans like federal loans in bankruptcy. Here’s why.

For federal loans, if you meet the criteria the government must provide you with the loan, and interest rates are capped. Not so for private label loans. Those lenders can (and do) charge high interest rates, refuse to lend to someone, require a cosigner, and determine how much money to lend. This puts private label lenders in the same position as other unsecured creditors – they decide if someone is a good credit risk and then impose interest and loan terms accordingly. As such, argue consumer advocates, private student loan lenders should not receive special treatment under the bankruptcy laws.

The Undue Hardship Standard

For all student loans, you must bring a separate action in the bankruptcy court, called a complaint to determine dischargeability, to get the loans discharged. To win, you must prove that repaying the loans would cause undue hardship.

In most of the country, bankruptcy courts use the Brunner test to decide if repayment would cause undue hardship. Under this standard, you can discharge your student loans if you meet all three of these factors:

  • Poverty.  Based upon your current income and expenses, you cannot maintain a minimal standard of living for yourself and your dependents if you are forced to repay your loans. A minimal standard of living is not a middle class standard, but a much lower standard of living. The courts expect you to maximize your income and minimize your expenses.
  • Persisitence.  Your current financial situation is likely to continue for a significant part of the repayment period.
  • Good faith.  You have made a good faith effort to repay your student loans.  

For the most part, the courts in the Second, Third, Fourth, Fifth, Sixth, Seventh, Ninth, Tenth, and Eleventh Circuits use the Brunner test.

In a few areas of the country (the Eighth Circuit and most courts in the First Circuit), the courts use the “totality of the circumstances” test.   For this standard, the court will look at all relevant factors in your case to determine if it is an undue hardship for you to repay your student loans.  

(To learn more about these standards, see Student Loans in Bankruptcy.)

Unfortunately, most student loan lenders will aggressively defend against an action to discharge student loans. This means most student loan debtors will have to pay a lawyer to help – and those fees can get quite high.  If your student loan tab is large, consider talking to a reputable local bankruptcy attorney about your chance of discharging your loans and how much you’ll end up paying in attorneys’ fees.

Using Chapter 13 Bankruptcy to Repay Student Loans

If you can't discharge your student loans, you may be able to get temporarily relief by paying a reduced amount through Chapter 13 bankruptcy. But keep in mind that you’ll still be on the hook for  whatever amount is left after your repayment period ends.  For detailed information on how Chapter 13 can help with student loans, see Nolo's article  Student Loans in Chapter 13 Bankruptcy.  

Other Repayment Options

The federal government has a number or repayment options for low-income borrowers – but unfortunately those options are only available for federal loans. However, if you are in default or struggling to pay your private label student loans, you can negotiate directly with the lender and try to get a lower payment or reduce your interest rate.

A few private student loan lenders have cancellation programs for death or disability.

Getting Help From the CFPB

The federal Consumer Financial Protection Bureau accepts complaints about private student loan lenders.  The CFPB can help with:  

  • getting a private student loan
  • repaying a private student loan
  • managing a student loan that has gone into default, or
  • dealing with a student loan that has been referred to a debt collector.

If you file an online complaint, the CFPB will give you a case number so you can track progress of the complaint.  It will forward your complaint to the financial institution involved and then keep track of progress. The CFPB says it expects to have cases come to resolution within 60 days. It’s unclear from the information on the CFPB’s website what role the ombudsman will take in resolving those issues.

The CFBP will use the information it gathers from borrowers’ complaints and stories to report to Congress on the private student loan industry. To learn more, see Problem With a Student Loan? Tell the CFPB.


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