When you’re going through bankruptcy, applying for a loan might be the furthest thing from your mind. The process leaves your credit in tatters — but that can change in a few years’ time if you make a consistent effort.
“People can absolutely recover from bankruptcy,” says Jordan van Rijn, senior economist at the Credit Union National Association. “It just takes time and quite a bit of patience.”
If you’re considering loans after bankruptcy, expect to wait at least a year or two before qualifying for traditional loans. But don’t count out other options. Here’s what you need to know.
What Is Bankruptcy?
Bankruptcy relieves most, if not all, of your debts but comes with a price: a damaged credit record and lower credit scores.
Two of the most common types of personal bankruptcy are Chapter 7 and Chapter 13.
In Chapter 13 bankruptcy, you can keep assets like a house or a car as long as you have a reliable income. You can get court approval for a repayment plan over three to five years, after which your debts will be discharged.
In contrast, Chapter 7 requires you to liquidate all eligible assets, although some items — such as cars and furnishings — could be exempt. And your income cannot exceed an amount designated by the government.
How Does Bankruptcy Affect Your Credit?
Bankruptcy will dramatically affect your credit score, and it will remain on your report for seven to 10 years, says Rod Griffin, senior director of consumer education and advocacy at Experian.
Discharging debt can help you start anew, but it doesn’t wash away the months or years of financial issues, such as missed loan payments and out-of-control balances. Those marks on your credit report will hurt your credit score for quite a while.
[Read: Best Bad Credit Loans.]
“After a Chapter 7 discharge, your credit scores will not necessarily bounce back. Although the accounts discharged in bankruptcy will no longer show a balance owed, they will still remain on your credit report,” Griffin says. “The status will show they were discharged in bankruptcy, and any late payments that occurred prior to when the bankruptcy was filed will also remain on your report for up to seven years.”
How Can You Raise Your Credit Score After Bankruptcy?
The most important task after bankruptcy is to repair your credit, which will eventually help you get approved for credit cards and loans again.
“The key to rebuilding your credit score is to have an open, active account with a history of on-time payments,” Griffin says.
Some consumers are able to keep an account or two when going through bankruptcy, which is called reaffirming the debt, Griffin says. “If this is the case, make sure every payment is made on time going forward so that you can show lenders you are managing the account responsibly,” he says.
A good way to start your road to credit recovery is to apply for a credit-builder loan. These are short-term loans that range from about $200 to $1,000 and are not used as an investment or to purchase anything in particular, van Rijn says. You can usually find them at credit unions or community banks.
Griffin suggests other ways you can build your credit score after bankruptcy:
— Apply for a secured credit card, a card with a credit line of usually less than $1,000 that is backed by your own money. Work with a bank or credit union where you already have a checking or savings account. If you make your payments on time for a while, you’ll likely move up to an unsecured card.
— Become an authorized user on an account. This could improve your credit score if the account is in good standing.
— Get a co-signer for a credit card or loan.
— Use a tool like Experian Boost or UltraFICO, which factors alternative data into your credit report by monitoring things like rent and utility payments. However, lenders might not use this data for your loan application.
How Long Does It Take to Get a Loan After Filing Bankruptcy?
For some loans, you’ll need to wait at least two years after bankruptcy before applying. You want to have a positive credit record and plenty of time between your loan application and bankruptcy.
[Read: Best Personal Loans.]
“It may be difficult to qualify for a loan after filing Chapter 7, especially if the bankruptcy was recent,” Griffin says. Whether you qualify will likely depend on several factors, such as:
— How long ago you filed for bankruptcy.
— Whether you have established a positive account history since your bankruptcy.
— The type of loan you are applying for.
“If you qualify, you will almost certainly have to pay higher interest rates and other fees, especially if your bankruptcy was recent,” says Griffin.
For example, if your credit score is still fair or very poor — which is considered under 670 on FICO — expect to pay a higher interest rate than someone with a higher score.
Here is a look at ways to get approved for common loans:
Unsecured loans: Credit cards and personal loans are types of unsecured loans. Soon after bankruptcy, you’re more likely to qualify for credit cards with high interest rates and low maximum balances (up to about $2,000) than for something like a $10,000 personal loan, van Rijn says.
Mortgages: It will likely take a few years to get your credit score high enough to be considered for a conventional mortgage with a reasonable interest rate.
The easiest way to qualify is likely with a government-backed loan with lower requirements for credit scores.
If you file Chapter 7 bankruptcy, you’ll wait at least two years after your loan discharge before you can apply for loans from the Federal Housing Administration or Department of Veterans Affairs. However, if you file for Chapter 13, your waiting period could be just one year after the start of your bankruptcy payout period for FHA and a year from your Chapter 13 filing date for VA.
Other types of mortgages you might qualify for may be less appealing, with high interest rates and balloon payments.
[Read: Best FHA Loans.]
“It may take some time before you can qualify for a mortgage or other large loan with a lower interest rate and more favorable terms, but try not to get discouraged,” Griffin says. “As long as you practice good spending and payment habits as you rebuild, in time your credit scores will begin to reflect that.
Beware Loan and Credit Scams
When you’ve been struggling for years to bring up your credit score, you may be tempted to look for shortcuts. But that’s exactly what unscrupulous companies are looking for when they trick you with loan and credit-building scams.
— Advance fee loans, in which you are guaranteed approval if you provide $100 or more, might be illegal. The Federal Trade Commission prevents anyone who guarantees that you will obtain a loan from asking for payment beforehand. Legitimate lenders will ask that you go through a loan approval process but will not guarantee acceptance upfront.
— Credit repair companies might make promises they can’t keep — such as removing accurate negative information from your credit report — and ask for upfront money. Know that you can take most credit improvement steps on your own, for free.
While recovering from bankruptcy, you may need to make major changes in how you spend and deal with debt while also planning for the future. It might be difficult to balance your post-bankruptcy recovery with a loan until you’re truly ready to handle that responsibility.
“Keep in mind, the point of bankruptcy is to reset your personal finances,” Griffin says. “If you are in a rush to take on more debt, you’ve missed the point.”
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