Personal Loans and Bankruptcy

Personal loans are usually quiet debt. They don’t come with a house or a car attached, so there’s nothing to repossess, but the balance can keep growing, and the monthly payment can become harder to manage. 

Many Washington residents took out personal loans for perfectly reasonable things: medical bills, a layoff at Boeing or one of the state’s seasonal industries, or credit card debt that has spiraled out of control. Then circumstances shifted, and the loan that was supposed to help became another weight pulling them under.

Personal loan debt rarely shows up on its own. It is often tangled up with credit cards, medical bills, housing costs, and the general pressure of falling behind. 

Erin Lane at Washington State Bankruptcy Lawyers has been handling these cases for over 16 years. Recognized as a Top 100 Trial Lawyer by the National Trial Lawyers, she has seen enough of these cases to know that personal loans are often just the tip of the iceberg.

If personal loan payments are eating into money you need for rent or groceries, it’s worth understanding how bankruptcy may help.

How Bankruptcy Treats Personal Loan Debt

Most personal loans are unsecured, meaning a house or car does not back them up. That is actually good news in bankruptcy, because unsecured debts are the easiest to discharge. 

Under 11 U.S.C. § 727, a Chapter 7 discharge eliminates the debtor’s personal liability on qualifying unsecured debts, and most personal loans qualify. The U.S. Courts bankruptcy overview breaks down how Chapter 7 works. 

Essentially, it’s designed to discharge most unsecured obligations and give the filer a clean slate. For someone carrying $15,000 or $30,000 in personal loan debt, this can mean the entire balance is eliminated without any repayment requirement. The process typically takes three to four months from filing to discharge.

In a Chapter 13 bankruptcy, the treatment is different. You’ll enter a three- to five-year repayment plan where you pay a portion of your unsecured debts based on your disposable income. 

Personal loans are grouped with other unsecured debts, and any remaining balance after you complete the plan is discharged. Many Chapter 13 filers end up paying only a fraction of their original personal loan balances.

Secured vs. Unsecured Personal Loans

Here’s where it gets a little more nuanced. The key question is whether your loan is secured or unsecured. 

Most personal loans from banks, credit unions, and online lenders are unsecured, meaning the lender relied on your creditworthiness rather than collateral when approving the loan. These unsecured personal loans are prime candidates for discharge.

However, some personal loans are secured by collateral. Credit unions in Washington State sometimes require a security interest in your savings account or vehicle as a condition of lending. 

If your loan is secured, the lender has a lien on the collateral, and bankruptcy doesn’t automatically eliminate that lien. Under 11 U.S.C. § 506, the secured portion of the claim is treated differently from the unsecured portion. Washington’s property exemptions under RCW 6.15.010 determine what property you can protect, but they don’t override a valid security interest.

This is one of the first things Erin Lane checks when reviewing a client’s situation: whether any of their personal loans have a security interest attached that could complicate things.

The Means Test and Qualifying for Chapter 7

Before you can discharge personal loan debt through Chapter 7, you must pass the means test. This calculation, established under 11 U.S.C. § 707(b), compares your household income to the median income for a household of your size in Washington State. 

If your income falls below the median, you generally qualify for Chapter 7 automatically. If your income is above the median, you’ll need to complete the full means test calculation, which accounts for allowable expenses and determines your disposable income. 

The U.S. Trustee Program publishes the median income figures used for this calculation. Washington’s cost of living, particularly in the Puget Sound region, means that many residents with seemingly moderate incomes still qualify for Chapter 7 once housing and transportation costs are factored into the calculation.

Co-Signed Personal Loans in Bankruptcy

This is one of the tricky situations in bankruptcy. If someone co-signed your personal loan, filing wipes out your obligation. However, the co-signer can remain reliable, meaning the lender can pursue the co-signer for the remaining balance.

Chapter 13 offers a specific protection that Chapter 7 does not: the co-debtor stay. Under 11 U.S.C. § 1301, when you file Chapter 13, the automatic stay extends to co-signers on consumer debts. This means the lender can’t pursue your co-signer while you’re making payments under your Chapter 13 plan. 

For many Washington families where a parent co-signed a child’s loan or spouses co-signed for each other, this protection plays a huge role in choosing between bankruptcy chapters.

Erin Lane frequently works with clients who are concerned about how their bankruptcy may affect family members who co-signed loans. She helps structure cases to minimize that exposure wherever possible.

Payday Loans and High-Interest Lending

Payday loans and other high-interest personal loans are fully dischargeable in bankruptcy. Washington State regulates payday lending under RCW 31.45, which caps loan amounts and imposes licensing requirements on lenders. 

Despite these protections, many Washington residents find themselves trapped in cycles of payday borrowing, rolling over loans and paying interest without ever reducing the principal.

The Consumer Financial Protection Bureau has written extensively about how payday loan cycles trap working families. Often, bankruptcy is the only way to break that cycle for good, as filing for Chapter 7 discharges payday loan balances entirely, giving you a fresh start.

However, if you took out a loan right before filing, the lender could argue it was taken in bad faith. Under 11 U.S.C. § 523(a)(2), debts obtained through false pretenses or fraud can be excepted from discharge. 

While this doesn’t come up often with ordinary payday loans, it is something your attorney should check before you file.

Personal Loans From Family and Friends

Money borrowed from family or friends counts as debt in bankruptcy, the same as a bank loan. You must list it on your schedules, and it’s subject to discharge. 

This surprises a lot of people. Often, they don’t think of the money they owe their parents or brother-in-law as a “debt” in the legal sense, but it is.

There’s an additional complication with family loans. If you repaid a family member more than $600 in the year before filing (or paid them preferentially over other creditors), the bankruptcy trustee can potentially recover those payments as preferential transfers. 

The American Bar Association explains that the look-back period for payments to insiders (which includes family members) extends to a full year before filing, compared to just 90 days for payments to regular creditors. This means timing is crucial when family loans are involved.

What Happens to Your Credit After Discharging Personal Loans

Discharging personal loans through bankruptcy affects your credit. However, the impact is often less severe than people expect, particularly when your credit is already damaged by missed payments and collection accounts. 

The Federal Trade Commission provides guidance on rebuilding credit after bankruptcy and notes that many begin receiving credit offers within months of their discharge.

A Chapter 7 bankruptcy remains on your credit report for 10 years, while a Chapter 13 stays for seven years. However, the practical impact lessens over time, and many Washington residents see their credit scores begin to recover within one to two years of discharge. 

The key is establishing new positive credit habits after bankruptcy, one of the topics covered in the required debtor education course.

Alternatives to Bankruptcy for Personal Loan Debt

Bankruptcy isn’t always the right answer for personal loan debt, and a responsible attorney will tell you that. Depending on your circumstances, there may be alternatives worth considering before filing:

• Debt negotiation or settlement, where you negotiate directly with lenders to pay less than the full balance owed on your personal loans
• Debt consolidation through a lower-interest loan, which can reduce monthly payments but doesn’t eliminate the debt itself
• Credit counseling through a nonprofit agency approved by the U.S. Trustee Program, which can help you develop a debt management plan
• Hardship programs that some lenders offer, which temporarily reduce payments or interest rates for borrowers experiencing financial difficulty

The National Consumer Law Center provides resources on consumer rights when dealing with debt collectors and exploring alternatives to bankruptcy. 

However, when personal loan debt is combined with other obligations and your total debt load exceeds what you can reasonably repay, bankruptcy often provides the most complete and lasting relief.

Protecting Your Property During Bankruptcy

“Will I lose my property?” is the most common question, and the answer for most Washington filers is no. Washington is an opt-out state, meaning you use state exemptions, not federal. Additionally, the state’s exemptions are fairly generous.

The main protections:

• A homestead exemption under RCW 6.13.030 that protects equity in your primary residence, with the amount adjusted periodically based on county median home values
• Personal property exemptions covering household goods, clothing, furniture, and other necessities up to specified dollar limits
• Retirement account protections that shield 401(k)s, IRAs, and pension funds from creditors and the bankruptcy trustee
• Vehicle exemptions that allow you to keep a car up to a certain equity value, which is particularly important in Washington’s more rural communities, where public transit isn’t an option

The Washington State Bar Association has resources on finding qualified bankruptcy attorneys, and this is one area where having an attorney really matters. Claiming the right exemptions correctly can be the difference between keeping everything and losing property you didn’t have to give up.

The Automatic Stay and Personal Loan Collectors

One of the most immediate benefits of filing bankruptcy is the automatic stay, which takes effect the moment your petition is filed with the court. Under 11 U.S.C. § 362, the automatic stay prohibits creditors from taking collection action against you. 

For someone being hounded by personal loan collectors, this means the phone calls stop, the threatening letters stop, and any pending lawsuits or wage garnishments are halted.

The automatic stay provides instant relief. If a creditor keeps calling or suing you after you’ve filed, they’re violating a court order and can be held in contempt. 

This protection applies to all personal loan creditors, including banks, credit unions, online lenders, payday lenders, and even family members who have been pressing you for repayment.

When Personal Loan Debt Signals a Larger Problem

When personal loan debt becomes unmanageable, it’s typically not the real problem; it’s a symptom. Many of Erin’s clients took out personal loans to cover other debts, and now they’re borrowing to repay their loans. 

The National Association of Consumer Bankruptcy Attorneys reports that most people who file for bankruptcy waited far longer than they should have, often taking on additional debt trying to avoid filing.

If you’re using personal loans to pay medical bills, cover basic living expenses, or make minimum payments on credit cards, that’s a signal that your debt load may have passed the point where incremental solutions will work. 

Bankruptcy addresses all these debts together rather than forcing you to settle each one individually.

Working With Washington State Bankruptcy Lawyers on Personal Loan Debt

Erin Lane examines the full picture, not just the loan balance. Your income, expenses, property, and debts all factor into whether Chapter 7 or Chapter 13 makes more sense. 

After 16 years of handling bankruptcy cases across Washington, Erin has seen just about every version of personal loan debt there is. She will assess your loans, determine what’s dischargeable and what’s not, and give you a clear picture of what filing would look like.

If personal loan debt is dragging you down, a conversation costs nothing. Schedule a free consultation with Erin Lane to discuss your options. You can also read more about how bankruptcy can help on our website.