Students in higher education can take out loans to help pay their educational expenses, including tuition, living expenses and books. A loan discharge occurs when the debt is reduced or canceled completely, often part of bankruptcy proceedings. Student loans are notoriously difficult to discharge in bankruptcy proceedings, and a discharge will still negatively affect your credit.
Student Loan Basics
Student loans are frequently guaranteed by the government, and these loans tend to have lower interest rates. Students may supplement government-backed loans with loans from private lenders, which frequently have higher interest rates. Students often take out private loans because these lenders may offer larger loans and pay the money directly to the student. Just as with any other loan, students are obligated to repay their loans. Most government loans do not begin accruing interest until the student graduates, while private loans may accrue interest while the student is still in school.
Defaulting on Loans
A default is a failure to pay the monthly loan payment. Late payments can affect your credit, but default is usually classified as being 60 days or more overdue on the loan. When students default, the entire loan may become due and payable and lenders may demand the entire sum, including default fees and penalties. A default may dramatically lower a student's credit score, which decrease or eliminate their ability to get credit. Because default often carries stiff penalties that a student can't afford, a student loan default may lead to a bankruptcy filing.
While most debts can be discharged in bankruptcy, student loans can't be discharged, except for extraordinary circumstances. When the debtor has no ability to repay the student loan, the bankruptcy court may discharge the loan. Permanent disability is a common reason for discharge, and loans may also be discharged if the school closes while the student is still attending. Loans may also be discharged if the loan was offered under fraudulent circumstances, such as another person signing the student's name. Discharge is better for a person's credit than default, but most students have already defaulted by the time they attempt to discharge the debt. Some public service workers are eligible for student loan discharge if they work in the public sector for a certain period of time. These discharges are not related to bankruptcy proceedings and, as long as the student is current on loan payments at the time of discharge, they do not harm credit.
Chapter 7 bankruptcies stay on a person's credit for 10 years, while Chapter 13 remain on a credit report for 7 years. When a discharge is part of bankruptcy, it will affect credit for the same length of time as the bankruptcy, and may inhibit ability to get any credit whatsoever. Discharges due to disability or public service work may not affect credit at all if the lender consents to discharge prior to default. When discharge is the result of a complete inability to pay, however, the discharge may be reported on the credit report as a charge-off, which can be extremely damaging to credit.
Fair Credit Reporting
The Fair Credit Reporting Act places limits on how long items can appear on your credit report. Private student loans remain on the credit report for 7.5 years, while federal student loans can be reported indefinitely. Note that a payment on a loan may restart the clock on credit reporting. If, for example, you default for four years and then make one payment, the loan will fall off 7.5 years after this payment, not 7.5 years from the original date. Private student loans that are not in default continue to remain on the credit report until the loan is paid off or 7.5 years after they enter default.
References & Resources
- Creatas/Creatas/Getty Images