After the fall of Silicon Valley Bank, and other banks such as student loan refinance lender First Republic showing signs of struggle, some borrowers hope their bank’s misfortune could mean some student debt gets erased.
Sadly, a bank going under or declaring bankruptcy usually isn’t good news for borrowers. While there have been reported instances of borrowers coming out ahead from a bank collapse, in most cases, they end up worse off.
In fact, the bankruptcy double standard is yet another example of how the deck is stacked against student loan borrowers.
Bank Failures and Your Student Loans
Many borrowers hope that a bank or lender going under means they no longer have to pay their student loans.
It is a reasonable theory at first glance. If the bank no longer exists, who collects the monthly check?
The problem for borrowers is that the debt is transferrable. The money owed to a lender is an asset that financial institutions can buy and sell. If you borrowed money from Bank A, and Bank A is desperate for cash, they might sell your loan to Bank B. At that point, you have to make payments to Bank B.
The terms of the original loan contract are almost always written so that the debt is transferrable.
Lender Hardships Usually Mean Problems for Borrowers
Having student loans move from one lender to the next isn’t just a minor inconvenience. For many borrowers, it results in a significant hardship.
When a loan holder changes, borrowers must adjust how they make monthly payments. For the borrowers that use automated bill pay, the transition to a new lender may cause issues and potentially missed payments.
In other words, the shift isn’t just a mere headache. The forced transfer to a new lender can result in late fees and adverse credit reporting.
Worse yet, the company that buys the debt may be especially hostile to borrowers.
The lenders that market directly to consumers are incentivized to have a good reputation. If the marketplace knows that a lender is awful, students will avoid that particular lender. Thus, some lenders cut borrowers some slack. This assistance might mean an extra deferment not required by the loan contract or forgiving the debt if the borrower dies.
If the new lender doesn’t market directly to consumers, they have less incentive to help struggling borrowers.
The Instances Where a Borrower Benefits from Lender Bankruptcy
I’m hesitant to include this information because it rarely happens, and I don’t want anyone to get their hopes up.
That said, it is a remote possibility that does exist.
In some rare cases, lenders do an awful job of keeping track of their records. If the bank or lender fails quickly and liquidates all of its assets, some loans could get overlooked.
I’ve heard anecdotal stories from borrowers who had loans with a lender who collapsed and then never received a bill.
Digital recordkeeping makes the odds of an accident happening especially remote.
Sherpa Tip: If you think your debt records might be permanently lost, it is a good idea to talk to an attorney in your state with collections experience.
The attorney can advise you on protecting your rights and let you know when you are legally in the clear.
The Bankruptcy Double Standard
Bankruptcy is an integral part of our financial system. It allows investors and consumers to seek a fresh start after a significant monetary setback.
If a lender fails and declares bankruptcy, the investors don’t get stuck with the lender’s debts. Their business failed, and they get to try again.
Borrowers don’t get the same second chance. If they attend college and it doesn’t work out, they don’t have an easy path to a fresh start. They carry a debt that could last for decades and fundamentally alter the trajectory of their life.
We saw this double standard play out when lender My Rich Uncle declared bankruptcy.
While there is some new hope for student loan borrowers in bankruptcy, borrowers have a long way to go before they get treated like business owners, home buyers, or credit card users in bankruptcy courts.