Janice Lozano
Personal loans are an appealing option for paying off student loans because they offer quick access to cash and can be discharged in bankruptcy. However, there are drawbacks to this approach. Personal loans often carry higher interest rates than student loans, and many lenders prohibit their use for paying off student debt. Additionally, paying off federal student loans with a personal loan results in the loss of federal protections and benefits, such as grace periods, deferment, and income-driven repayment plans. Therefore, while it is possible to pay student loans with a personal loan if the lender allows it, there are risks and restrictions associated with this option.
| Characteristics | Values |
|---|---|
| Interest rates | Personal loans have higher interest rates than student loans. However, personal loans can have lower interest rates than private student loans depending on the lender and credit score. |
| Protections | Personal loans can be discharged in bankruptcy, unlike student loans. However, paying off a student loan with a personal loan means losing federal protections and benefits such as grace periods, forbearance, and income-driven repayment plans. |
| Lender approval | Many lenders do not approve of using personal loans to pay off student loans and prohibit this in their loan agreements. |
| Speed | Personal loans can provide quick access to cash, which can be beneficial for those struggling with student loan payments. |
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What You'll Learn
Personal loans may have higher interest rates than student loans
Personal loans can be used to pay for large expenses, such as weddings or home renovations, and are a popular way to consolidate debt or pay off high-interest debt. However, using a personal loan to pay off a student loan is generally not recommended. This is because personal loans often have higher interest rates than student loans.
Personal loans can be discharged in bankruptcy, whereas student loans cannot. Lenders view personal loans as a riskier form of debt, so they charge higher interest rates to offset that risk. The national average interest rate for a personal loan was 11.48% in Q2 2023, according to the Federal Reserve. In comparison, the interest rate for a federal student loan is currently 5.5% for an undergraduate degree and 7% for a graduate degree.
While it is possible to get a lower interest rate on a personal loan if you have good credit, this is not always the case, and you may end up paying more overall. Additionally, many lenders do not approve of using personal loans to pay off student loans, and it can be challenging to find a lender that allows it.
If you are considering using a personal loan to pay off a student loan, it is important to carefully weigh the pros and cons and ensure you understand the terms and conditions of the loan agreement.
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Student loans have protections that personal loans don't
Personal loans can be used for large expenses, such as weddings or home renovations, and are a popular way to consolidate debt or pay off high-interest debt. Interest rates for personal loans are often lower than those for credit cards, and they can sometimes be lower than interest rates on private student loans, depending on the lender and your credit score. However, student loans have certain protections that personal loans do not.
Firstly, personal loans can be discharged in bankruptcy, whereas student loans are not exempt from bankruptcy. This means that if you take out a personal loan to pay off your student loan, you will lose the protection of not being able to declare bankruptcy on your student loan debt. Secondly, federal student loans come with additional protections, such as access to federal loan repayment programs, grace periods for repayment, and public service loan forgiveness (PSLF). By taking out a personal loan to pay off a federal student loan, you will lose access to these benefits, including any current forbearance periods.
In addition, states in the US are taking action to protect borrowers of private student loans from predatory lending practices and abuses by lenders, servicers, debt buyers, and debt collectors. This includes requiring enhanced disclosures for cosigners and setting standards for lenders offering new loans with "cosigner release" benefits. These protections are specific to private student loans and may not be available with personal loans.
Therefore, while taking out a personal loan to pay off a student loan may be a viable option in some cases, it is important to consider the potential loss of protections and benefits associated with student loans. It is crucial to thoroughly understand the terms and conditions of any personal loan before signing any agreements.
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Personal loans can be discharged in bankruptcy
Personal loans can be used to pay off student loan debt, but there are some important considerations to keep in mind. Firstly, personal loans generally have higher interest rates than federal student loans, and taking out a personal loan to pay off student loans means losing the protections that come with federal loans. These protections include access to federal loan repayment programs, grace periods, and public service loan forgiveness.
However, one advantage of using a personal loan to pay off student loan debt is that personal loans can be discharged in bankruptcy. Bankruptcy is a legal process that provides individuals with a fresh start by eliminating or reducing their debt obligations. There are two primary types of bankruptcy for individuals: Chapter 7 and Chapter 13.
Chapter 7 bankruptcy involves the liquidation or sale of the debtor's assets to pay off debts. It is often a quicker and less expensive way to eliminate unsecured debt, such as personal loans, credit card debt, medical bills, and old utility bills. Chapter 7 bankruptcy is typically for individuals with low income and few assets. It is important to note that not all personal loans are dischargeable in Chapter 7 bankruptcy, as secured loans may require the surrender of collateral, such as a vehicle or property.
On the other hand, Chapter 13 bankruptcy allows individuals to reorganize their debts and make payments over time according to a court-mandated plan. Any remaining debt after completing the plan is then discharged. Unsecured personal loans may be fully discharged, fully repaid, or partly repaid and partly discharged under Chapter 13.
While bankruptcy can provide a financial fresh start, it is not without consequences. Obtaining new loans after bankruptcy, including personal loans, may be challenging and come with high-interest rates and less favourable terms. Therefore, while personal loans can be discharged in bankruptcy, it is a serious decision that requires careful consideration and understanding of the potential risks and impacts.
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Student loan refinancing may be a better option
On the other hand, refinancing your student loan can often result in a lower interest rate and lower monthly payments. It is a popular option for student loan borrowers, and there are many lenders that offer refinancing options. You can also customize your repayment plan to fit your budget and life circumstances.
If you have good credit and meet the lender's minimum income and other requirements, you may qualify for a better interest rate and more favourable terms when refinancing. However, it is important to note that refinancing federal student loans with a private lender means losing access to federal loan forgiveness and income-driven repayment plans.
Before deciding to refinance, it is recommended to check if your lender offers a co-signer release option and to take advantage of federal loan benefits such as income-driven repayment or financial hardship forbearance. You can also get assistance from a nonprofit financial counselling agency to better understand how to manage your student debt.
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Lenders may not approve personal loans for student debt
Secondly, personal loans often require a documented employment history, which may not be feasible for students or recent graduates. Lenders generally review income and debt information, such as pay stubs, tax returns, and credit reports, to assess an applicant's ability to repay the loan. A lack of sufficient employment history or a low income may lead to loan disapproval.
Additionally, personal loans do not offer the same protections as federal student loans. Federal loans provide benefits such as income-driven repayment plans, grace periods, and public service loan forgiveness (PSLF). By using a personal loan to pay off federal student loan debt, borrowers forfeit these protections.
Moreover, some personal loan companies explicitly prohibit using the funds to repay student loans. This is because student loans are not exempt from bankruptcy, while personal loans can be discharged in bankruptcy. Lenders may be reluctant to approve personal loans for student debt repayment due to this distinction.
Lastly, credit score requirements for personal loans can be challenging for students or individuals with limited credit history. While some lenders may approve loans with poor credit scores, the interest rates offered are typically higher. In contrast, federal student loans often have more flexible credit score requirements, making them more accessible to borrowers with varying credit histories.
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Frequently asked questions
Yes, you can pay off your student loan with a personal loan, but it is not always a good idea. Personal loans often have higher interest rates than student loans, and you may lose the protections that come with federal student loans.
If you pay off your federal student loan with a personal loan, you will lose access to federal loan repayment programs, grace periods for repayment, and public service loan forgiveness. You will also lose the current forbearance period, which allows you to pause payments and interest accrual on your federal student loans.
One benefit of using a personal loan to pay off your student loan is that personal loans can be discharged in bankruptcy, which is not the case with student loans. Personal loans can also provide quick access to cash, which could be helpful if you are struggling with your student loan payments.
