Private Student Loans and Bankruptcy: Lessons from the Second Circuit
Understanding how recent Second Circuit decisions reshape the rules for discharging private student loans in bankruptcy.
For years, many borrowers believed that student loans could never be wiped out in bankruptcy. Recent decisions from the U.S. Court of Appeals for the Second Circuit have helped dismantle that myth, especially for private student loans. These rulings interpret the Bankruptcy Code in a way that makes some private education debts dischargeable in ordinary bankruptcy proceedings, without meeting the demanding “undue hardship” standard.
This article explains what changed, how the Second Circuit approached the law, and what it may mean for borrowers, lenders, and bankruptcy practitioners.
Why the Second Circuit’s Ruling Matters
The Second Circuit, which covers New York, Connecticut, and Vermont, issued a key decision in Homaidan v. Sallie Mae, Inc. (Navient) that addressed when private student loans are protected from discharge. The court focused on a narrow question: whether certain private student loans fit within the phrase “obligation to repay funds received as an educational benefit” in Section 523(a)(8)(A)(ii) of the Bankruptcy Code.
The court concluded that the loans at issue were not obligations to repay “educational benefits” in the sense Congress intended, and therefore were not automatically excluded from discharge. This ruling aligns the Second Circuit with the Fifth and Tenth Circuits, which had already adopted similar interpretations.
- Immediate significance: Some private student loans in Second Circuit states can be treated like other unsecured consumer debts and discharged in a standard bankruptcy case.
- Broader impact: The decision contributes to a growing trend among federal appellate courts recognizing that not all student-related loans are categorically nondischargeable.
- Practical result: Borrowers and attorneys now have clearer arguments to challenge the nondischargeable status of certain private education loans.
Understanding Section 523(a)(8): Three Key Categories
Section 523(a)(8) of the Bankruptcy Code identifies particular education-related debts that cannot be discharged unless the borrower proves “undue hardship”. The statute is structured around three main categories, which the Second Circuit read narrowly:
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| Category | Statutory reference | Basic description |
|---|---|---|
| Government or nonprofit-backed loans and benefit overpayments | 523(a)(8)(A)(i) | Loans or overpayments made, insured, or guaranteed by the government or a nonprofit institution. |
| Educational benefits, scholarships, and stipends | 523(a)(8)(A)(ii) | Obligations to repay funds received as an educational benefit, scholarship, or stipend. |
| Qualified education loans | 523(a)(8)(B) | Private loans that meet the tax-code definition of “qualified education loan” for eligible institutions and expenses. |
The central dispute in Homaidan concerned the second category—what counts as an “obligation to repay funds received as an educational benefit”. Loan servicers had argued that this phrase covers virtually all private student loans, regardless of structure. The Second Circuit rejected that broad reading and adopted a targeted interpretation focused on conditional grants and similar arrangements.
How the Second Circuit Interpreted “Educational Benefit”
In Homaidan, the Second Circuit carefully parsed the wording of Section 523(a)(8)(A)(ii). Rather than treating “educational benefit” as a catch-all for any loan used to pay for schooling, the court understood the term to refer to specific types of funding arrangements:
- Conditional grants: Funds given on the condition that the recipient satisfies certain obligations, such as service or academic performance.
- Scholarships and stipends: Financial support that may have repayment obligations if conditions are not met.
- Non-traditional arrangements: Support that looks more like a grant than a conventional loan but has a contingent repayment feature.
The court emphasized that if “educational benefit” were read to include all private student loans, it would make other parts of Section 523(a)(8) redundant and contradict Congress’s choice to treat different categories separately. By confining the phrase to grants, scholarships, and similar programs, the Second Circuit preserved the distinct role of the “qualified education loan” provision in subsection (B).
As a result, private loans that do not meet the definition of a “qualified education loan” and do not fall under the government/nonprofit category may be discharged like other unsecured debts, without requiring an undue hardship showing.
Which Private Student Loans May Be Dischargeable?
Not all private student loans become easily dischargeable because of this decision. The crucial question is whether a given loan fits within any of the three protected categories in Section 523(a)(8). If it does not, then it can be discharged in a standard Chapter 7 or Chapter 13 case, just like credit card debt or medical bills.
According to guidance from the Consumer Financial Protection Bureau (CFPB) and recent case law, some private education-related loans are outside Section 523(a)(8) altogether. These include, for example:
- Loans used to attend schools that are not eligible for federal Title IV student aid, such as unaccredited colleges or certain foreign institutions.
- Loans to cover fees and living costs while studying for professional licensing exams (for example, the bar exam).
- Loans related to medical or dental residency expenses, including moving costs and living expenses.
- Loans to students enrolled less than half-time.
- Private loans that exceed the school-certified cost of attendance.
When these loans do not satisfy the definition of “qualified education loan” and do not fall into the other categories, they are simply unsecured consumer obligations subject to ordinary discharge rules.
Interaction with Federal Loans and Undue Hardship
The Second Circuit’s decision does not change the status of federal student loans, which are generally nondischargeable unless the borrower proves undue hardship under Section 523(a)(8). Federal loans are typically government-backed and squarely within the first statutory category.
To discharge those loans, borrowers usually must:
- File an adversary proceeding within the bankruptcy case, specifically asking the court to determine whether repaying the loans would cause undue hardship.
- Provide detailed evidence of income, expenses, efforts to repay, and future prospects.
- Litigate the issue, or reach a settlement with the U.S. Department of Justice (DOJ) and the U.S. Department of Education when federal loans are involved.
Recent DOJ guidance has introduced a more structured process for evaluating undue hardship claims, including the use of a formal Attestation Form that bankruptcy debtors submit. This form gathers information about current and future ability to pay, and the debtor’s good faith efforts to manage the loans. Based on this information, government attorneys may recommend full or partial discharge, or modified repayment terms.
Private loans that do qualify as “qualified education loans” under Section 523(a)(8)(B) generally face the same undue hardship standard. The Second Circuit’s decision does not eliminate that protection for lenders but clarifies that it applies only when statutory requirements are met.
Practical Steps for Borrowers Considering Bankruptcy
Borrowers who are overwhelmed by student debt and considering bankruptcy should approach the issue systematically. The CFPB and nonprofit advocacy organizations emphasize that discharging student loans is difficult but not impossible. The following steps can help structure the analysis:
1. Identify the Type of Each Loan
- Gather promissory notes, account statements, and correspondence from servicers.
- Determine whether each loan is federal, private, or some hybrid product.
- Check whether the private loan is school-certified and limited to the official cost of attendance.
- Confirm whether the school was eligible for Title IV federal aid at the time of enrollment.
This information helps evaluate whether a loan might fall outside Section 523(a)(8) and be more readily dischargeable.
2. Review Bankruptcy History and Court Orders
- If you have already filed for bankruptcy, locate the discharge order and your schedules listing debts.
- Confirm whether you ever filed an adversary proceeding related to student loans.
- Compare current billing statements to the debts listed in the bankruptcy case.
In some cases, servicers may continue collecting on loans that were in fact discharged because they did not fall within Section 523(a)(8). Borrowers in that situation may need to document payments and seek legal assistance.
3. Consider an Adversary Proceeding for Remaining Student Loans
- Consult a bankruptcy attorney or legal aid organization familiar with student loan issues.
- If the loan appears to be within Section 523(a)(8), prepare to allege and prove undue hardship.
- For federal loans, be prepared to complete the DOJ Attestation Form and provide thorough documentation.
Even if the case is already closed, courts may allow reopening the bankruptcy to bring an adversary proceeding targeting student loans.
Implications for Lenders and Servicers
For private lenders and servicers, the Second Circuit’s interpretation carries significant compliance and litigation implications. Some loans previously treated as automatically nondischargeable may now face discharge in ordinary bankruptcy proceedings.
Key considerations include:
- Loan structuring: Products that exceed cost of attendance or serve non-Title IV institutions may not qualify for Section 523(a)(8) protection.
- Servicing practices: Collecting on debts that have been discharged can expose lenders to sanctions for violating the discharge injunction.
- Litigation risk: Borrowers may file class actions or adversary proceedings challenging ongoing collection of loans that do not meet statutory criteria.
- Documentation: Maintaining clear records of how loans were originated, including school eligibility and cost-of-attendance calculations, is increasingly important.
Courts have emphasized that lenders cannot rely on broad, informal understandings of “student loans” when determining dischargeability; they must fit the specific categories Congress defined.
Frequently Asked Questions (FAQs)
Are all private student loans now easily dischargeable in the Second Circuit?
No. The Second Circuit’s ruling clarified that not all private student loans fit within the “educational benefit” category of Section 523(a)(8)(A)(ii). However, private loans may still be protected as “qualified education loans” under Section 523(a)(8)(B) or as government/nonprofit-backed loans under subsection (A)(i). Only loans outside all three categories are dischargeable like ordinary unsecured debt.
Does the Second Circuit decision affect federal student loans?
It does not change the basic rule for federal student loans. Federal loans remain generally nondischargeable unless the borrower proves undue hardship through an adversary proceeding. The decision is focused on the interpretation of private loans and the “educational benefit” language.
How do I find out if my private loan is a “qualified education loan”?
Determining whether a loan is a “qualified education loan” typically requires examining whether the loan was used for eligible expenses at an eligible institution, within cost-of-attendance limits. Borrowers should review loan documents, school records, and consult legal or tax professionals to evaluate this status.
Can student loans be discharged in bankruptcy at all?
Yes. Multiple sources, including the CFPB and nonprofit legal assistance organizations, emphasize that student loans can be discharged in bankruptcy under certain circumstances. Some private education-related loans are discharged in a normal case, while others—especially federal loans and qualified education loans—require an undue hardship determination.
What should I do if I suspect a discharged loan is still being collected?
Borrowers should document billing statements and payments, gather bankruptcy orders and loan documents, and seek legal advice. They may also submit a complaint to the CFPB, attaching supporting information. In some instances, ongoing collection after discharge can be challenged as a violation of the bankruptcy discharge injunction.
References
- Second Circuit Rules Private Student Loans May Be Discharged in Bankruptcy — Consumer Financial Services Law Monitor. 2021-07-21. https://www.consumerfinancialserviceslawmonitor.com/2021/07/second-circuit-rules-private-student-loans-may-be-discharged-in-bankruptcy/
- Second Circuit Holds That Certain Private Student Loans May Be Dischargeable Under Section 523(a)(8)(A)(ii) — Jones Day. 2021-08-12. https://www.jonesday.com/en/insights/2021/08/second-circuit-holds-that-certain-private-student-loans-may-be-dischargeable-under-section-523a8aii
- Second Circuit Follows Other Recent Circuit Opinions Re: Private Student Loan Discharge — Financial Services Perspectives (Bradley). 2021-07-21. https://www.financialservicesperspectives.com/2021/07/second-circuit-follows-other-recent-circuit-opinions-re-private-student-loan-discharge/
- The Revival of Student Loan Discharge in Bankruptcy by the Tenth and Second Circuits — Cardozo Law Review. 2021-11-15. https://www.cardozolawreview.com/the-revival-of-student-loan-discharge-in-bankruptcy-by-the-tenth-and-second-circuits/
- Busting Myths About Bankruptcy and Private Student Loans — Consumer Financial Protection Bureau. 2022-01-27. https://www.consumerfinance.gov/about-us/blog/busting-myths-about-bankruptcy-and-private-student-loans/
- Bankruptcy — Student Loan Borrower Assistance (NCLC). 2023-05-01. https://studentloanborrowerassistance.org/for-borrowers/dealing-with-student-loan-debt/loan-cancellation-forgiveness-bankruptcy/bankruptcy/
- New Process to Discharge Student Loans in Bankruptcy — National Consumer Law Center Digital Library. 2023-02-10. https://library.nclc.org/article/new-process-discharge-student-loans-bankruptcy
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