Can a Creditor Seize Student Loans?

Few things are as scary or disruptive as the potential for a large levy of your bank accounts or the garnishment of your wages. For those whose student loans represent the promise of a better tomorrow, a creditor's judgment may be the kick that sends them into the financial abyss. Student loans are protected from creditors, although excess disbursements may not be.

Student Loans

The proceeds from student loans are not, in themselves, subject to seizure by creditors. A loan is a contract among the student, the lender and the school -- the student, as borrower, does not have custody of the funds and has no authority to redirect them to discharge a debt. However, some schools permit a student to withdraw the school's maximum possible federal award even if the student won't use all the dollars for qualified educational expenses; in that case, any loan proceeds not used for qualified educational expenses are returned to the student as a lump-sum distribution.

Judgments

If a debtor fails to respond to a creditor or a judge determines that the debtor isn't acting with sufficient speed to discharge a valid debt, the court can issue a judgment. This guarantees the legal validity of the debt. If a debtor refuses to pay, the creditor can ask the judge to issue a garnishment -- the seizure of part of a person's paycheck -- or a lien against some asset like a house or car. A judge can also authorize a levy.

Bank Levies

A levy entitles the creditor, under the court's authorization, to seize funds from a deposit account to pay a specific debt. If a student with a $5,000 refund from a maximized student loan puts that $5,000 into his checking account, it is possible a levy could be applied against that money. Most courts have paperwork that allows debtors to identify some parts of their income as being protected from levy (such as child support), but in the absence of that documentation, a creditor can empty the account again and again until the judgment is satisfied.

Credit Availability

Some students prefer to obtain student loans from private sources, like the family's bank or credit union. Unlike federal loans, private loans occasionally entail a creditworthiness assessment. Judgments significantly impair credit ratings, so it's possible that an unsatisfied judgment could create a significant credit risk to future student-loan awards.