Understanding Bankruptcy and Loan Possibilities
The exact circ*mstances surrounding your bankruptcy and ongoing financial situation can affect the type of loans you may qualify for and the terms a lender is willing to offer. Your bankruptcy filing will remain on your credit report for up to 10 years, which may lead to higher interest rates and stricter repayment terms on any loan you qualify for.
Types of Bankruptcy
There are several different types of bankruptcy, but only two of them apply to individuals: Chapter 7 and Chapter 13.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is also known as liquidation, and it’s an option you can pursue if you can’t make regular monthly payments toward your debt, regardless of the amount of money you owe.
Filing for Chapter 7 can allow you to discharge many of your debts, which would mean you’re no longer liable for them. For the remaining debts, a trustee typically sells your assets, such as jewelry or property besides your primary home, for cash and then uses that money to pay your creditors. State and federal laws govern the definition of “exempt” property.
To qualify for Chapter 7 bankruptcy, your current monthly income must be less than the median income in your state. If your income exceeds that threshold, you must pass a “means test” to ensure you’re not abusing the protections of Chapter 7. Basically, this means the court will look to see if you’re not actually making enough money to pay your debt.
This type of bankruptcy generally ends quickly, meaning you’ll be able to start rebuilding your credit and preparing your finances for new loans. However, lenders may view a Chapter 7 bankruptcy on your record as a significant red flag.
Chapter 13 Bankruptcy
The other bankruptcy option for individuals is Chapter 13. You need to have a regular income to qualify for Chapter 13. Unlike liquidation bankruptcy, this “wage earner’s plan” gives you a plan to repay your debts over three to five years without having to sell your assets for cash.
One of the most significant advantages of Chapter 13 is that filing can stop foreclosure proceedings, often allowing you to keep your home. Additionally, creditors cannot contact you directly once you are under Chapter 13 protection.
To qualify for Chapter 13, you must have a regular income, and the total value of all your secured and unsecured debts must be less than $2,750,000, according to the federal court system.
This bankruptcy action is similar to a consolidation loan in that you make a single monthly payment that goes toward all your debts. Once you file and get approval for a three-year or five-year plan, you make a monthly payment to a designated trustee, who then makes payments to your creditors.
This type of bankruptcy takes longer to complete, since you have a three- or five-year payment plan. This means it will take longer for you to be able to qualify for new loans – but lenders will likely look at a Chapter 13 bankruptcy more favorably than a Chapter 7.
Loan Types Post-Bankruptcy
Although it may be more difficult, you can still qualify for a loan following bankruptcy. It may be easier to qualify for a secured personal loan (such as a mortgage or secured credit card), which requires collateral. However, this option is riskier because the lender can repossess your collateral if you default on the loan.
Qualifying for an unsecured personal loan may be more difficult because a potential lender is less likely to recover the money if you stop making payments. However, some lenders offer loans specifically for borrowers who have gone through bankruptcy or have bad credit. While these loans may have fewer eligibility requirements, they may come with high interest rates, fees or unfavorable repayment terms.
How To Get a Loan After a Bankruptcy
If you work on rebuilding your credit following bankruptcy, it can make it easier to qualify for a personal loan in the future. Two of the most important factors in rebuilding your credit are making all your payments on time and improving your financial habits to avoid getting into overwhelming debt again. If you have a cosigner with good credit, it may be easier to qualify for a loan and get lower interest rates after bankruptcy.
Once you’re ready to apply for a personal loan after bankruptcy, the first step is to do a credit check so you know your score. You’ll need to know your credit score in order to check rates or prequalify with multiple lenders to compare possible offers. Once you have loan details from several lenders, compare the rates, terms and fees to determine which one is right for your financial situation.
You may want to look for lenders that offer programs specifically for people recovering from bankruptcy. However, be wary of predatory lenders that set extremely high interest rates or add expensive fees and prepayment penalties to the loan.
Alternatives to Personal Loans After Bankruptcy
If you need financing at some point after bankruptcy, a personal loan isn’t your only option. Some other financing approaches may be better suited for your unique financial situation.
Secured Credit Card
One possibility is a secured credit card. With this type of credit card, you start by depositing money with the bank or credit card company. Those funds prove that you can pay your bill, and your available credit line is some percentage of the deposit (typically between 50% and 100%). A secured credit card can help you rebuild your credit score and reduce the risk of overspending.
Peer-to-Peer Lending
Another option is to pursue a loan via peer-to-peer lending. Unlike traditional loans that are funded by banks, credit unions or other lenders, these unsecured loans are funded by individuals. Most peer-to-peer loans are facilitated by an online platform that connects potential borrowers with potential lenders. It can be easier to find a lender willing to fund your request, but you may have to pay higher fees and interest rates than with a traditional personal loan.
>> Related: Learn more about peer-to-peer lending
Credit Builder Loan
You could also consider applying for a credit builder loan (CBL). This is a specific type of loan designed to help you establish or improve your credit score and build up some savings. With a CBL, you don’t receive the money you borrow right away. Instead, the lender places it in a savings account and holds it as collateral while you repay the loan.
You will receive the money if you make all your payments (including interest and principal) over the loan term. Some lenders release small portions of the loan amount when you make payments, while others give you the lump sum when the repayment term ends. Either way, a CBL allows you to improve your credit score by making regular payments. It also helps prevent you from overspending because you don’t get the borrowed money until after you’ve “repaid” it. However, if you need funding right away, a CBL probably isn’t the best option.
>> Related: Learn more about credit-builder loans
The Bottom Line
Declaring bankruptcy can affect your creditworthiness for several years, making it harder to qualify for a personal loan or get a loan with favorable terms. If you do need to borrow money after bankruptcy, you may be able to get a secured loan (which requires collateral). However, some lenders offer loans specifically for borrowers who have bad credit or have gone through bankruptcy. These loans often come with high interest rates and fees. Rebuilding your credit by making on-time payments and avoiding extra debt can make you more eligible for loans later on.
However, there are other potential funding options. A secured credit card and a credit builder loan both allow you to prove your ability to repay the loan and make it more difficult to overspend the borrowed funds. However, a peer-to-peer loan may be a better option if you need money right away. Evaluate every loan option’s pros and cons to decide which is right for your financial situation.
Frequently Asked Questions About Personal Loans After Bankruptcy
No law prevents you from applying for a loan after bankruptcy, but you do have to wait until all your debts are discharged, which can take several months with Chapter 7 or up to five years with Chapter 13. Additionally, the bankruptcy can remain on your credit report for up to 10 years. Rebuilding your credit can make it easier to qualify for a loan, although lenders may still charge higher interest rates and fees while a bankruptcy is still on your credit report.
Some lenders may not offer you a line of credit until after your bankruptcy falls off your credit report. Others may be willing to provide you with a secured credit card, which requires you to deposit the money for your credit line up front to lower the lender’s risk. If you are considering a home equity line of credit (HELOC), you’ll have to wait until you have adequate equity in your home and a credit score that meets the lender’s requirements.
If you file for Chapter 7 bankruptcy, most of your debts can be discharged, except for alimony, child support payments, taxes, personal injury payments and some criminal restitution orders. More types of debt, including those related to a separation or divorce, may be discharged in Chapter 13. Student loan debt may also be discharged during bankruptcy, although it often requires you to complete a few extra steps.
You’ll have to wait at least until all your debts have been repaid according to your Chapter 13 schedule, which will be either three or five years. However, bankruptcy can stay on your credit report for up to 10 years, which may make it difficult to get a loan with favorable terms. Rebuilding your credit and improving your financial stability can help you qualify for a loan, especially if you work with a lender that offers a program for post-bankruptcy borrowers.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
If you have feedback or questions about this article, please email the MarketWatch Guides team ateditors@marketwatchguides.com.
David GregoryEditor
David Gregory is a sharp-eyed content editor with more than a decade of experience in the financial services industry. Before that, he worked as a child and family therapist until his love of adventure caused him to quit his job, give away everything he owned and head off to Asia. David spent years working and traveling through numerous countries before returning home with his wife and two kids in tow. His love of reading led him to seek out training at UC San Diego to become an editor, and he has been working as an editor ever since. When he’s not working, he’s either reading a book, riding his bicycle or playing a board game with his kids (and sometimes with his wife).
