If you’ve just gone through a bankruptcy, you might feel a little vulnerable financially. You’ve been promised a clean slate, but your credit score has taken a hit and it could take months or even years to get to a point where you can qualify for a loan that isn’t highly expensive.
You need credit to build credit though, and one way to start building your credit after you’ve gone through bankruptcy is through a personal loan.
Yes, it is possible to get a personal loan after bankruptcy. But in order to find one that isn’t predatory in nature, it’s important to understand where you stand, how to properly prepare, and where to look.
Part I: How personal loans after bankruptcy can help you build credit
As you work to get your credit back on track after bankruptcy, a personal loan could certainly help. That’s because the most important factor in your credit score is your payment history, and making on-time payments on your personal loan after bankruptcy helps establish a positive payment history.
What is a personal loan?
An unsecured personal loan is a loan that doesn’t require collateral that the lender can repossess if you default on your payments.
What are my odds of getting approved?
Many lenders don’t offer unsecured loans for people who have a bankruptcy on their record, but there are a handful who specialize in exactly this type of loan. The trick is finding one that isn’t predatory in nature.
“When a person files for bankruptcy, they are seeking a debt solution that results in partial or complete liquidation of the debt they owe,” says Bruce McClary, Vice President of communications for the National Foundation for Credit Counseling.
“This leads to a financial loss for their lenders,” he adds. “Because of that fact, and that the set of circumstances leading to their bankruptcy may not be completely resolved, lenders will continue to view bankruptcy filers as a risk.”
There are two types of consumer bankruptcy: Chapter 7 and Chapter 13. Each has a different impact on your credit and your chances of getting approved for after-bankruptcy loans.
Chapter 7 bankruptcy
With a Chapter 7 bankruptcy, you’re required to sell off certain assets to pay off eligible outstanding debts.
A Chapter 7 bankruptcy gives you more of a clean slate, so to speak, than a Chapter 13 bankruptcy. But it remains on your credit report for longer — up to 10 years, according to McClary.
McClary also warns that lenders may look less favorably on a Chapter 7 bankruptcy because it doesn’t involve a repayment plan like a Chapter 13 bankruptcy. As a result, it may be tougher to get a personal loan after Chapter 7 discharge.
You don’t have to wait the full 10 years for your credit score to improve though. As you start establishing positive credit habits, and as your bankruptcy moves further into the past, the positive habits will gain in importance and the negative impact of your Chapter 7 bankruptcy will fade. So the sooner you start rebuilding your credit, the better.
Chapter 13 bankruptcy
While a Chapter 7 bankruptcy eliminates your eligible debts entirely, a Chapter 13 bankruptcy calls for a reorganization of your debts and finances.
You’ll set up a repayment plan through the court system, typically over a three to five year period, during which you’ll make payments to a trustee who then distributes the payments to creditors who have filed claims against you. Unlike a Chapter 7 bankruptcy, Chapter 13 doesn’t require you to sell off any personal property to pay down your debts.
People typically opt for a Chapter 13 bankruptcy when they don’t meet the eligibility requirements for a Chapter 7 bankruptcy.
While you’re stuck making payments for a few years, however, a Chapter 13 bankruptcy won’t remain on your credit report as long as a Chapter 7 bankruptcy.
“Anyone who files and successfully completes a Chapter 13 can see the bankruptcy information on their credit report for seven years,” says McClary
And since it takes much longer than a Chapter 7 bankruptcy, which can be processed in months, McClary says that you may be able to apply for a loan before the bankruptcy is discharged.
But as with a Chapter 7 bankruptcy, your Chapter 13 bankruptcy won’t ruin your credit for the full seven years. If you manage to get approval for a loan during your repayment period, you can start establishing a positive payment history sooner rather than later.
Part II: Applying for a personal loan after bankruptcy
How to prepare your loan application
If you’re interested in getting a personal loan after bankruptcy, it’s critical that you present yourself in the best way possible.
Get a copy of your credit reports
You can get a free copy of your credit reports once per year from all three credit bureaus — Equifax, Experian, and TransUnion — through AnnualCreditReport.com. Once you have your credit reports, you can check to see if the information is accurate and up-to-date.
For example, if you filed Chapter 7 bankruptcy, make sure that all your eligible debts were included in the bankruptcy and that they’re now showing a zero balance. If you filed Chapter 13, check to see that your payments are being applied correctly.
If any information is inaccurate, you can file a dispute to have it corrected or removed from your credit report altogether.
Make sure your income is accurate
Your credit report and score are just two that factors lenders consider. In some cases, proving that you have sufficient income to repay a loan can make you appear less risky.
Your reportable income is based on your current income, so if you’ve received a raise recently, make sure to include that in your calculation. Also, include any other income that you have reasonable access to, such as cash you’ve earned from a side business or a spouse’s income.
Be prepared with the right documents to prove your income. This may include pay stubs, bank statements, a W-2, or tax returns.
Be ready to make your case
If your application gets denied off the bat, you may still have a chance to make your case. Be ready to explain what led you to declare bankruptcy and your commitment to building better credit habits. There’s no guarantee that doing this will overturn a denial, but it doesn’t hurt to try.
Part III: Shopping for an unsecured personal loan after bankruptcy
Finding a lender who’s willing to offer personal loans for discharged bankruptcies can be hard, but it may be worth the effort.
“Although lenders will view a recent bankruptcy filer as a risk, they may still be willing to approve them for financing,” says McClary. “Most lenders will offset the risk with higher interest rates and additional fees, which makes it costlier for the borrower.”
Here are a few options to consider.
If you already have an established relationship with a community bank, you may have a better chance of getting approved, especially if you’ve been with the bank for years and know someone at the local branch.
Big banks often don’t specialize in personal loans after bankruptcy, however, so you might not find success going this route.
A local credit union
Credit unions are different from banks in that they’re not-for-profit organizations owned by their members. As a result, credit unions are generally more focused on serving the community than generating profits and may be more lenient with bad credit.
That said, credit unions often require that you become a member before you can apply for a loan. And if you’re a new member without a history with the credit union, it may be more difficult to secure a loan.
There are several online lenders that specialize in loans for people with bankruptcy or generally poor credit.
LendingTree, which owns MagnifyMoney, can help you find these lenders. If you fill out a short online form, you may be able to get some quotes from lenders based on a soft credit check. That way you can compare offers to determine which one best suits your needs and your budget.
Lenders like LendingClub and Prosper are unique in that instead of lending you money directly, they act as an intermediary between individual lenders and individual borrowers.
Since some individual lenders may be willing to invest in higher-risk loans, you might have an opportunity to get approved even with a bankruptcy.
Other options if you’re rejected for a personal loan
While you may be able to get an unsecured personal loan after bankruptcy, but there’s no guarantee you’ll be approved. Each lender has a different set of criteria, and they consider several factors before making a decision.
So, if you do end up getting denied, it’s important to know what your alternatives are. Here are some of the major options to consider.
Find a co-signer
While it can be difficult to get approved for a personal loan after bankruptcy on your own, you’ll have a much better chance if you can manage to find someone to cosign the loan with you.
This could be a family member or close friend. Keep in mind, however, that cosigning means that they’re lending more than just their good name. Your co-signer will be equally responsible for repaying the debt, and it could hurt their credit if you default.
You may want to avoid this option if you think that something could go wrong and harm your relationship.
Apply for a secured personal loan
If an unsecured personal loan isn’t available, you might have some luck putting up collateral for a secured personal loan. Some examples of eligible collateral include:
- Real estate, such as equity in your home
- Insurance policies
Before you choose this option, you should understand the risks involved. Your collateral may be worth more than the loan itself, and you could lose your collateral if you default, which could cause more financial problems.
Apply for a secured credit card
Secured credit cards are similar to secured personal loans in that you need to put up collateral to get approved. The difference is that your collateral is a cash deposit, typically equal to your desired credit limit.
Other than the security deposit, a secured credit card functions the same as a conventional credit card. One big benefit of using a secured card to rebuild credit is that as long as you pay off your balance in full each month, you don’t ever have to pay interest.
That said, some secured cards charge annual fees, as well as high APRs, so they’re not ideal if you plan to carry a balance.
Part IV: How to rebuild your credit after bankruptcy
As you’re working to get your credit back on track, it’s important to know how your actions affect your credit score.
Here’s a list of factors that FICO uses to calculate your credit score, along with how important they are:
- Payment history (35% of your score)
- Amounts owed (30%)
- Length of credit history (15%)
- Credit Mix (10%)
- New credit (10%)
The most important thing you can do to boost your credit score is to make payments on time. By applying for an unsecured personal loan after bankruptcy, you can get an account with a lender who will report your monthly payments.
How much you owe is also important, so avoid borrowing more than you need. Consider applying for a secured credit card and maintaining a low balance. This will help you maintain a low credit utilization rate, which is an important element of the “amounts owed” factor.
Having both a secured credit card and unsecured personal loan can help diversify your credit mix, but you should be careful about submitting too many applications; too much new credit can hurt your score.
The bottom line
If you’re looking to rebuild your credit after a bankruptcy, using an unsecured personal loan can be a great way to re-establish a positive payment history.
It’s important to understand, however, that these unsecured personal loans can come with high interest rates. Do the math to make sure it’s worth the cost by considering the fees and interest involved, as well as your monthly payments.
It’s best to use a personal loan after bankruptcy if you have a legitimate need for the money. Borrowing and paying interest is a more costly way to build credit than, say, using a secured credit card and paying your balance in full each month, thereby avoid interest payments altogether.
Take your time to consider all of your options before making a decision. Shop around to make sure you’re getting the best deal. It’s not a guarantee that you’ll get a low interest rate, but you can avoid loans with the highest interest rates if you do it right.
Finally, don’t take it personally if you get denied. Lenders often don’t know you personally; all they see is what’s on the paper in front of them. So, if you do get denied, start working on an alternative and improve your credit to increase your chance of getting approved in the future.
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