Can You Erase Student Loan Debt Through a Loophole?

Can You Escape Student Loan Debt Through a Loophole? In a recent article on little-known facts about student loan debt, we covered why bankruptcy is almost never an option for getting around overwhelming student loan debt burdens. The article prompted a reader to pose the following question:

The other day I was participating in a discussion on Twitter. Someone suggested that using a credit card to pay off student loans was the way to go. Why? They felt as though they would then be able to have the debt erased in bankruptcy because it would now be considered credit card debt and not federal student loan debt.

Any thoughts on this? I wondered how far back the bankruptcy courts would look to see if this is indeed what happened and, if so, if this could backfire on those who are using the technique. Is it a viable solution (for those who don’t genuinely plan to file bankruptcy at the time they make the payment)?

It’s an excellent question and one that we felt deserved a closer look, especially for anyone who might be considering this option. In theory, charging your student loan debts on a credit card in order to circumvent the bankruptcy rules certainly sounds like a perfectly sensible solution. The reality, however, is quite the opposite. Is it possible? Maybe. Is it wise? Probably not. Here are three big reasons why this is a bad idea all the way around:

1. Your Credit Card APR Is Higher Than Your Student Loan Rate

The first, and most obvious reason not to finance student loans on a credit card is the financial impact from interest. If we’re assuming for a moment that this option is for those who don’t genuinely plan to file bankruptcy at the time they make the payment, the interest rate they’d end up paying on a credit card versus a traditional student loan just makes this a bad financial choice.

Interest rates on student loans are much, much lower than the average interest rates on credit cards. And for those who’ve already qualified and taken out a traditional student loan as a means of financing, it begs the question — why would you trade one debt for a debt that’s even worse? This could raise a few red flags and possibly lead to allegations of fraud, which leads me to the next point.

2. Credit Card Fraud Is a Crime

Credit card issuers weren’t born yesterday and they’re well versed in the potential for fraud surrounding bankruptcy filings. In which case, it’s important to understand that if an issuer has any reason to suspect fraudulent activity on an account, they can (and will) go back and flag any charges that appear suspicious — including student loan payoffs.

If a credit card issuer determines that any of the charges were made for fraudulent purposes– circumventing student loan bankruptcy laws, for example — the issuer is fully within their legal rights to press criminal charges. If you intentionally charge student loan debt on your credit cards for the sole purpose of circumventing the bankruptcy laws on student loan debt, and then file bankruptcy, you’re committing fraud.

Get matched with a personal loan that’s right for you today.

Learn more

If the tactic backfires and you get caught, credit card fraud is a criminal offense. In this case, you have to ask yourself: Is getting around the laws for filing bankruptcy on student loan debt really worth the risk of getting caught?

3. Planning to Go Into Bankruptcy Is Quite Difficult

One last drawback to this theory assumes that you’ve paid for college using a credit card, rather than transferred a student loan balance to a credit card. Even if someone does technically end up in dire straits and is able to file a Chapter 7 bankruptcy (where all debt is included in the bankruptcy and wiped away), it’s not usually a situation that can be planned out years in advance. I’m not saying that it can’t be done, just that Chapter 7 bankruptcies are a lot more difficult to qualify for and in order to make this work, you would have to meet income requirements determined by the state in which you live in. Do you really know how much you’ll be making five, 10 or 15 years from now?

If you don’t meet the income requirements for Chapter 7, then you’re looking at a Chapter 13. Even though you may be able to significantly reduce the amount of debt you owe in Chapter 13, you’ll still be required to pay a portion of the debts –and this includes the credit cards that you’ve used to charge your student loan debt in attempt to get around the bankruptcy rules. If the whole idea is to use your credit cards to erase student loan debt, this can put a damper on your initial plan. This also assumes that you’re willing to damage your credit and your future capacity to qualify for a home loan, a car loan, or any other type of financing you might need in the foreseeable future.

If you’re concerned about how your debt could be impacting your credit, you can check your three credit reports for free once a year at AnnualCreditReport.com. If you’d like to monitor your credit more regularly, Credit.com’s free Credit Report Card provides you with an easy to understand breakdown of the information in your credit report using letter grades, along with two free credit scores, and they are updated every 14 days.”

For a more in-depth look at student loan issues and the growing problem surrounding student loan debt, here are few resources and must-read features from Credit.com:

Image: iStockphoto