When you are struggling with overwhelming debt, the option of bankruptcy often comes to mind. But one important question remains: Can personal loans be discharged in bankruptcy? Personal loans, which are typically unsecured debts, may be eliminated in bankruptcy under certain circumstances. However, the dischargeability depends on several factors, including the type of bankruptcy filed and the loan’s purpose.
In this guide, we’ll explore everything you need to know about discharging personal loans through bankruptcy, and help you understand the specific rules surrounding this process.
Key Points:
- Most unsecured personal loans can be discharged in bankruptcy.
- Fraudulent loans or those for specific purposes may not be discharged.
- Chapter 7 and Chapter 13 bankruptcy handle personal loans differently.
What Is Bankruptcy, and How Does It Affect Personal Loans?
Bankruptcy is a legal process that allows individuals or businesses to eliminate or reorganize their debts under the protection of the federal court. There are two main types of bankruptcy that individuals usually file for—Chapter 7 and Chapter 13.
- Chapter 7 Bankruptcy: Often referred to as liquidation bankruptcy, Chapter 7 allows most unsecured debts to be discharged. In this case, your assets may be sold to pay off creditors, and the remaining unsecured debts, including personal loans, can be eliminated.
- Chapter 13 Bankruptcy: Known as a reorganization bankruptcy, Chapter 13 involves creating a repayment plan to pay back a portion of your debt over a period of 3 to 5 years. After completing the plan, the remaining eligible debt can be discharged.
In both cases, personal loans may be discharged, but the process differs depending on the type of bankruptcy filed.
How Are Unsecured Personal Loans Handled in Bankruptcy?
Personal loans are typically unsecured, meaning there is no collateral tied to the loan. Because of this, personal loans are usually eligible for discharge in bankruptcy.
For example, if you have an unsecured personal loan from a bank, credit union, or online lender, this loan can be wiped out in both Chapter 7 and Chapter 13 bankruptcy. However, certain exceptions apply, and creditors might challenge the discharge if there was any fraud or misrepresentation when you took out the loan.
Let’s break it down further:
In Chapter 7 Bankruptcy: Most unsecured debts, such as personal loans, credit card debts, and medical bills, are discharged. But remember, if the personal loan was obtained through fraudulent means, it could be contested.
In Chapter 13 Bankruptcy: While your personal loan may not be fully discharged, Chapter 13 provides a plan for repaying a portion of your debt over time, and any remaining balance may be forgiven after successful completion of the plan.
What Are the Exceptions to Discharging Personal Loans?
While most unsecured personal loans can be discharged, there are some exceptions. These exceptions depend on the circumstances under which the loan was obtained or used. Some key exceptions include:
- Fraudulent Loans: If the loan was taken out with fraudulent intent or misrepresentation, it may not be dischargeable. For example, if you lied about your income to qualify for a loan, the creditor can challenge the discharge in bankruptcy.
- Recent Large Purchases: If you took out a personal loan to make recent large purchases, such as luxury items or gambling, the court might find that the loan should not be discharged.
- Loans from Friends and Family: Personal loans obtained from friends or family may be treated differently depending on the circumstances of the loan.
Example: If you took out a loan right before filing for bankruptcy to buy a luxury car, the court may rule that the loan is not dischargeable, especially if it was obtained with the intent to keep the car after filing.
Chapter 7 vs. Chapter 13 Bankruptcy: Which One is Better for Discharging Personal Loans?
The way personal loans are handled in bankruptcy differs between Chapter 7 and Chapter 13. Let’s compare the two to help you understand which one might be better for discharging your personal loans.
| Bankruptcy Type | How It Affects Personal Loans | Key Advantages |
| Chapter 7 | Eliminates most unsecured debts, including personal loans | Quick and efficient debt elimination |
| Chapter 13 | Requires repayment plan; some loans may be partially discharged after completing plan | Allows you to keep assets like a home or car |
Chapter 7 is typically the best option if you want to eliminate your personal loans quickly and completely. However, Chapter 13 might be a better option if you have assets you want to protect, but you’ll have to pay a portion of your debts over time.
Can Personal Loans from Friends or Family Be Discharged?
Personal loans from friends or family are a bit tricky in bankruptcy. While these loans are considered unsecured, they can sometimes be treated differently than loans from traditional lenders. The dischargeability of these loans largely depends on the nature of the loan and the relationship with the lender.
If the loan was made in good faith and without fraudulent intent, it may be discharged in bankruptcy. However, if the loan was structured to avoid repayment or was made under suspicious circumstances, it may not be dischargeable.
How Can I Protect Myself from the Consequences of Discharging Personal Loans?
Filing for bankruptcy can have serious consequences, and it’s essential to understand how it affects your financial future. Some steps you can take to protect yourself include:
- Consult a Bankruptcy Attorney: A qualified attorney can guide you through the bankruptcy process and help you understand your rights regarding personal loans.
- Avoid Fraudulent Behavior: Always disclose accurate information when applying for loans. Fraudulent behavior can lead to challenges from creditors and the court.
- Plan for the Future: Bankruptcy should be viewed as a fresh start. After your personal loans are discharged, it’s crucial to build a stronger financial foundation, including improving your credit score.
Conclusion
Personal loans can be discharged in bankruptcy, especially in Chapter 7 cases. However, there are important exceptions, such as loans obtained through fraud or for luxury items. Understanding how bankruptcy works and how it affects your personal loans is crucial for making the best decision for your financial situation.
Filing for bankruptcy can be a complex and life-changing decision, so make sure to consult a bankruptcy attorney to ensure you’re fully aware of your rights and obligations.
FAQ’s
- Are all personal loans dischargeable in bankruptcy?
- Most personal loans, especially unsecured ones, can be discharged. However, loans obtained through fraud or for luxury items may not be.
- How long does it take to discharge a personal loan in Chapter 7 bankruptcy?
- It can take a few months for Chapter 7 bankruptcy to discharge personal loans, with most cases taking around 3 to 6 months.
- Can I keep my house or car if I discharge personal loans in bankruptcy?
- In Chapter 7, you may lose non-exempt assets. In Chapter 13, you may be able to keep your assets if you follow the repayment plan.
- What happens if a creditor challenges the discharge of my personal loan?
- If a creditor challenges the discharge, they must prove fraud or other non-qualifying factors. The court will review the evidence before making a final decision.
- Can I discharge personal loans from friends or family?
- Loans from friends or family may be dischargeable unless they were made under fraudulent circumstances or with the intent to avoid repayment.
- Will filing for bankruptcy affect my credit score?
- Yes, bankruptcy will negatively impact your credit score. However, it can also provide an opportunity for a fresh financial start.
- Can I still take out personal loans after bankruptcy?
- Yes, but it may be harder to qualify for loans, and interest rates may be higher due to the impact on your credit score.
- How do I know if my personal loan qualifies for discharge?
- A bankruptcy attorney can help you determine whether your personal loan qualifies for discharge based on the circumstances surrounding the loan.