How to Discharge Private Student Loans

Discharging private student loans in bankruptcy is notoriously challenging. The statutory framework governing student loans is designed to render most “educational” debt presumptively non-dischargeable. This means that when you file for bankruptcy under Chapter 7 or Chapter 13, your private student loan debt typically remains unaffected by the discharge order. This means you will still owe the full amount of your private student loans after your case is finished, and interest may continue to accrue during the bankruptcy proceedings.

However, there are exceptions to this general rule. This article will explore some common ways in which a private student loan may be eliminated in bankruptcy.

A Brief History of Private Student Loan Dischargeability

The treatment of student loans in bankruptcy has evolved considerably over the past few decades. Initially, student loans were treated like any other unsecured debt, meaning they could be wiped away in bankruptcy without special provisions.

One classic story about student loans that has been passed down to me by elder bankruptcy attorneys is particularly relevant. Before student loan reforms were enacted, medical students would often incur significant student loan debt throughout medical school. Upon graduation, it was not uncommon to see bankruptcy lawyers setting up tables outside the ceremony, ready to help these new doctors easily discharge all their medical school debt through bankruptcy. Recognizing the potential for widespread abuse, the U.S. government quickly moved to close this loophole, leading to the more stringent regulations on student loan dischargeability we see today.

Governement backed student loans first became non-dischargeable with the enactment of the Education Amendments of 1976. This legislation included a provision that made federally guaranteed student loans non-dischargeable in bankruptcy for a period of five years following the start of the repayment period, unless repaying the loan would cause undue hardship to the debtor or their dependents. This marked the beginning of the trend towards more restrictive dischargeability of student loans in bankruptcy.

Private student loans didn’t officially became non-dischargeable until the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) in 2005. Before this act, only government-backed or nonprofit-issued student loans were generally non-dischargeable. The BAPCPA extended the non-dischargeability provision to include “qualified educational loans,” which encompasses private student loans. This significant legislative change made it much more challenging for borrowers to discharge private student loan debt through bankruptcy.

In 2021, the Biden Administration sought to expand options for discharging federal student loans. Their proposal introduced streamlined procedures, such as an adversary attestation process where borrowers can argue in court that repaying their federal loans would impose undue hardship. Additionally, upon filing the adversary complaint, the government automatically provides a detailed breakdown of all federal loans in question. While these measures have simplified the process for eliminating federal loans, private loans, mainly held by individual private entities, do not benefit from these streamlined procedures.

Identifying Your Student Loan: Federal or Private?

The initial step in the process involves identifying your lender. Identifying private student loans can be challenging, especially since the loan servicer collecting payments may not be the original lender. Start by compiling a comprehensive list of all your student loans. Then, access the Department of Education’s Federal Student Aid database using your FSA ID. This database contains information on all federal loans; any loans not listed there are likely private. You can also confirm with your servicer for further clarity.

Also, some of the federal loan servicers are:

• MOHELA
• Nelnet
• Aidvantage
• HESC/Edfinancial
• Great Lakes Educational Loan Services (no longer in operation)

If your loan servicer isn’t among these listed companies, there’s a strong likelihood that your loan is private. I think the most direct approach would be to contact your servicer and inquire whether your student loan is federal or private.

Determining Whether a Private Loan is actually an Educational Loan

If you are certain that your loan is private, the next step in the analysis should be to determine whether it is a “qualified educational loan” under 11 U.S.C. § 523(a)(8). This statute explicitly states which private student loans are not dischargeable in bankruptcy:

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual;

To demonstrate that your loan should not be categorized as a “student loan” by the court, two key arguments can be presented: first, that it does not qualify as a legitimate educational loan; and second, that it does not meet the criteria outlined in IRS Code 221(d)(1).

Arguing Against Qualified Educational Loans

Determining whether a loan qualifies as an educational loan under 11 U.S.C. § 523(a)(8) involves several critical factors:

1. Purpose of the Loan: The loan must have been intended to cover educational expenses such as tuition, fees, room, board, and other related costs. There is even caselaw that indicates that a Bar Exam Loan borrowed by a lawyer may not qualify as educational.
2. Use of the Loan: How the loan proceeds were actually used by the borrower is crucial. If the funds were used for non-educational purposes, this could affect the dischargeability.
   • Tuition Answer Loans, originally marketed by Sallie Mae and now primarily serviced by Navient, often present strong cases for dischargeability. The loan amounts typically far exceed tuition costs, suggesting funds were likely used for non-educational expenses.
3. Eligibility of the Institution: The institution where the debtor studied must be eligible under federal student aid programs.
4. Loan Origination and Disbursement Process: The process by which the loan was originated and disbursed can also be a factor, especially if the loan bypassed the school’s financial aid office.

Factors Affecting Educational Loans

Determining whether a loan qualifies as an educational loan under bankruptcy law involves gathering some key evidence:

1. Loan Documentation: Reviewing the original loan agreement and how the loan was marketed can indicate its intended purpose for educational expenses.
   • Documents to gather:
     • Original loan agreement
     • Promotional materials or disclosures
2. Use of Funds by Borrower: Courts assess how loan proceeds were utilized by the borrower. Using funds for personal expenses may disqualify the loan as an educational loan.
   • Documents to gather:
     • Bank statements showing use of funds
     • Receipts or invoices for expenses paid with loan funds
3. School Certification: Whether the educational institution certified the loan as necessary for educational purposes is crucial.
   • Documents to gather:
     • Certification from the school
     • Correspondence with the school’s financial aid office
4. Borrower’s Educational Status: The borrower’s enrollment status and whether they were pursuing a degree or certificate program also play a role in the determination.
   • Documents to gather:
     • Enrollment verification
     • Proof of degree program enrollment

These documents can help substantiate your case regarding the classification of your loan under bankruptcy law.

Specific Types of Dischargeable Private Student Loans

In many instances, certain private student loans taken out for specific purposes are dischargeable in bankruptcy. These include:

1. Loans issued to students enrolled less than half-time: These loans are often taken out when students are pursuing part-time studies, making them eligible for discharge.
2. Loans for fees and living expenses during bar exam or other professional exam preparations: These loans are used to cover the costs associated with preparing for important professional exams, such as the bar exam, and can be discharged.
3. Loans covering costs and living expenses for medical or dental residency: Loans taken to cover the substantial costs of medical or dental residency programs are also dischargeable.
4. Loans for education at non-Title IV eligible institutions: This includes loans for education at unaccredited colleges, schools in foreign countries, or unaccredited training and trade certificate programs, making them eligible for discharge.
5. Loans exceeding the cost of attendance: These are loans that go beyond the direct educational expenses, such as tuition, books, room, and board, and are typically disbursed directly to the borrower.

Understanding which private student loans are dischargeable can significantly impact financial planning and provide relief for those struggling with educational debt.

Relevant Case Law on Educational Loan Determination

Case law has played a significant role in interpreting the statute and determining what constitutes an educational loan. Here are a few notable cases:

1. In re Homaidan: This case from the Eastern District of New York held that private loans which were not used solely for educational expenses did not qualify as nondischargeable educational loans under § 523(a)(8).
2. In re McDaniel: The Tenth Circuit held that private loans not certified by the school and not used directly for tuition and fees did not meet the definition of a qualified education loan and were thus dischargeable.
3. In re Teran: The Northern District of California concluded that loans used for expenses not directly related to attendance at an eligible educational institution were dischargeable.

Another Approach to Proving Your Loan Isn’t Qualified: The Federal School List

IRS Code Section 221(d)(1) offers a direct method to establish that a loan is not qualified. The statute defines two critical terms:

(1) Qualified education loan —The term “qualified education loan” means any indebtedness incurred by the taxpayer solely to pay qualified higher education expenses

(2) Qualified higher education expenses —The term “qualified higher education expenses” means the cost of attendance at an eligible educational institution…for purposes of the preceding sentence, the term “eligible educational institution” has the same meaning given such term by 26 U.S.C. section 25A(f)(2)

26 U.S.C. § 25A(f)(2) provides:

(2) Eligible educational institution —The term “eligible educational institution” means an institution (A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of enactment of this section, and (B) which is eligible to participate in a program under title IV of such Act.

If your school is not listed on the Title 9 School Code List, it is not considered an eligible educational institution. Therefore, any private student loans taken out for attending such a school are not considered qualified education loans under the IRS code. As a result, under the bankruptcy code they may be discharged in both Chapter 7 and Chapter 13 bankruptcy proceedings. However, it’s important to note that it is still possible to discharge private student loans even if your school is on the Title IV list.

Practical Strategies for Discharging Private Student Loans in Bankruptcy

Discharging private student loans in bankruptcy can be done in two ways:

1. Adversary Proceeding During Bankruptcy Case: Some attorneys recommend filing an adversary proceeding while the bankruptcy case is open. This allows for a determination of dischargeability by the court within the bankruptcy proceedings.
2. Motion for Declaratory Judgment After Discharge: Alternatively, another strategy is to wait until after the bankruptcy case has been discharged. If creditors attempt to collect on the private student loans post-discharge, you can file a motion for declaratory judgment and sanctions for violating the discharge injunction. This approach addresses dischargeability issues in response to creditor actions after the bankruptcy case concludes.

The choice between these approaches can depend on the specifics of your case, including timing, creditor behavior, and legal strategy tailored by an experienced attorney like Steven J. Grace.

Contact Steven J. Grace, Expert Student Loan Attorney

Navigating the discharge of private student loans in bankruptcy is a complex challenge, requiring deep knowledge of statutory requirements and intricate legal interpretations. Steven J. Grace, with his extensive expertise in this field, offers crucial insights into the historical context, statutory framework, and pertinent case law that are essential for anyone facing this daunting process.

For borrowers, meticulous documentation of loan fund usage is paramount, along with maintaining clear records of educational expenses. Mr. Grace remains vigilant in staying updated on evolving case law and statutory amendments to effectively advocate for his clients.

As interpretations of 11 U.S.C. § 523(a)(8) continue to evolve in court, there’s potential for shifts in the landscape of discharging private student loans, which could offer clarity and relief to struggling borrowers. Until then, understanding the current legal framework and strategic planning are indispensable for those seeking to discharge private student loans through bankruptcy.