When debts simply cannot be paid, it may make sense to file for bankruptcy. While this might feel like the end of the world, it’s actually just a chance to reset your finances.
Over time, you’ll be able to rebuild your credit after bankruptcy and develop sustainable money habits.
Here’s what to know about applying for loans post-bankruptcy.
In the short term, bankruptcy wrecks your finances. Your credit score will drop, and your credit cards will likely be canceled.
You’ll have to pay higher interest rates for loans (if you can get them). Potential employers and landlords who pull your credit report will see that you declared bankruptcy, which could affect their decision to give you a job or an apartment.
This might feel unfair, especially if the bankruptcy filing resulted from a major illness or something else you couldn’t control.
But the fact remains that you failed to pay your debts in a timely fashion or, in the case of Chapter 7 bankruptcy, that you failed to pay them at all.
“Bankruptcy is the most negative action that can appear on a credit report,” says Rod Griffin, senior director of consumer education for Experian.
Can you get a personal loan after bankruptcy? Maybe. Some lenders might take a chance once they know more about your situation. For example, having maxed out multiple credit cards is not the same as having been hospitalized for months after a car accident.
“There are extenuating circumstances, and lenders may be willing to work with you,” Griffin says.
Even so, it’s best to wait at least a few years to borrow. Personal loan options for the recently bankrupt aren’t as good as they are for people with good credit.
But if it’s crucial that you get a loan now, here’s what you need to know in order to get the best possible deal.
A secured loan requires you to provide collateral, such as a vehicle or a piece of property. If you fail to make payments, you lose your collateral. Secured loans are offered by banks, credit unions and some online lenders.
You’re allowed to keep certain assets after declaring bankruptcy. Yet using them as collateral for a secured loan is risky, especially if your finances are still shaky.
For example, if you get a vehicle title loan and miss a payment, you could lose your wheels and be unable to get to work.
An unsecured loan is just what it sounds like: Someone gives you money without any real guarantee that you’ll repay it. That’s a risk for the lender – and someone who recently declared bankruptcy looks especially risky when applying for an unsecured loan.
This doesn’t necessarily mean you can’t get an unsecured loan after filing bankruptcy. It just means you’ll generally pay a lot for the privilege of borrowing.
Chapter 7 bankruptcy, also known as “liquidation” bankruptcy, includes the sale of many of your assets in order to repay some of your debt. It stays on your credit report for 10 years.
However, you can apply for new credit (including loans) as soon as the bankruptcy case has been completed.
Chapter 13 is sometimes called the “wage earner’s plan.” It lets you keep your assets if you pay some or all of your debts via a court-ordered repayment schedule. Chapter 13 bankruptcy remains on your credit report for up to seven years.
Here’s where it gets complicated:
With Chapter 13, new credit generally isn’t allowed except for certain special circumstances, such as emergency home repairs (such as fixing the roof). You need court authorization to get a loan, so check with the court system or the bankruptcy trustee before signing any paperwork.
Kim Miller, a certified financial counselor in St. Paul, Minn., suggests exploring all options before applying for a post-bankruptcy loan.
For example, suppose your car breaks down and you want to fill out a loan application to cover costs. Could you join a carpool, take public transit, ride your bike, ask friends for rides to work or borrow a vehicle until you save up enough to pay for repairs instead? Might a relative or friend be willing to pay for the repairs and have you pay them back?
Even if it turns out you need the loan anyway, “doing the research means you can make the best decision,” says Miller, of the nonprofit LSS Financial Counseling.
If you absolutely must borrow after filing bankruptcy, be sure to compare unsecured loans.
Credit unions are likely your best bet, since they’re generally more willing to work with people who’ve had financial mishaps. (Some specialize in it).
Credit unions also have lower interest rates: As of December 2019, credit unions charged an average 9.36% interest rate on 36-month unsecured personal loans, compared to 10.18% at banks.
Note: Ask the credit union(s) in your area about “payday alternative loans,” which don’t necessarily require a good credit score. You can borrow up to $2,000 and take up to 12 months to pay it back. Not every credit union offers them, however.
If you’re already using a bank, it can’t hurt to inquire about a personal loan.
However, some banks don’t give unsecured loans to people with low credit scores. You might be able to borrow if a relative or friend with good credit is willing to cosign the loan.
Online lenders are more willing to lend if your credit score is 550 or higher. However, it might take time to improve your credit score after bankruptcy, and online lenders charge high interest rates. This is especially true of “subprime” lenders, who specialize in consumers with poor credit scores.
Look around and you’ll see personal loan interest rates from 4.99% to 20.89% offered by credit unions, banks and online lenders.
Unless you can boost your credit score quickly and also get the lender to overlook your bankruptcy, you’ll likely pay the higher rates.
Subprime lenders charge even more. Their unsecured personal loan rates can go as high as 35.99%, which means a much higher monthly payment.
But it isn’t just the interest that’s going to cost you.
Depending on the lender you’ll also pay an origination fee and possibly an application fee of 1% to 8% of the loan amount. Certified financial planner Linda Jacob has even seen “balance fees,” assessed every two weeks through the life of the loan.
“You think you’re getting a 17% interest rate, but then there’s a fee. You have to read the fine print,” says Jacob, who works at Consumer Credit of Des Moines.
A few other options:
Payday loans. They’re easy to get, but these loans often make a bad financial situation worse. The average interest rate on a payday loan is about 400% and the loans must be repaid within two weeks.
Critics say that a payday loan often traps borrowers in a cycle of borrowing and re-borrowing.
Peer-to-peer lenders, funded online by individual investors. These also generally have high interest rates if your credit history/score aren’t stellar.
“They’re not payday loans but they’re not great, either,” says Miller, who recently saw a 78% interest rate on a P2P loan.
Tribal loans, offered by online lenders affiliated with Native American tribes. These loans can carry interest as high as 1,800% or more.
You’ll have to get the court’s permission if you’re still in the repayment plan of a Chapter 13 bankruptcy to get a car loan.
If you filed for Chapter 7, you can probably get a car loan immediately – but it’s important to shop around rather than take the first offer you see.
No matter which type of bankruptcy you filed, start your auto loan search with a credit union. These institutions tend to be more willing to work with consumers who’ve had financial problems.
And if you can’t find a credit union to work with you? Look online, but look carefully. Never give a potential lender your Social Security number until you’ve looked for online reviews of the company and checked it through the Better Business Bureau.
Some red flags to watch out for:
Read the paperwork very carefully, and be absolutely certain that you can afford the payments. Defaulting on the loan won’t just mean having the car repossessed – it will also have a bad effect on your already compromised credit score.
On the bright side, having a vehicle loan could help improve that score. It shows that you’re making timely payments (35% of your FICO score) and also improves the “credit mix” (10% of your FICO score).
However, it also increases your overall indebtedness – and when you apply for a loan (including mortgages) or credit card, potential lenders will look closely at your debt-to-income ratio.
Note: Be wary of “buy here, pay here” auto lots. Their vehicles are often older and unreliable, a large down payment may be required, and some dealers won’t quote you a price until they’ve checked your credit report.
These sellers also charge very high car loan interest rates; according to Experian’s “State of the Automotive Finance Market” quarterly report, people with bad credit scores below 500 paid an average interest rate of 21.23% when financing through independent dealers.
It generally takes at least two and possibly four years to get a mortgage after bankruptcy. The time varies depending on your personal situation, the type of mortgage and the lender’s requirements.
For example, a government-backed FHA loan or VA loan might be easier to get than a conventional mortgage. A mortgage lender might look more favorably on a Chapter 13 bankruptcy, in which you pay back your debts, than a Chapter 7, which erases your obligations.
Credit scores matter, too.
Most conventional lenders want to see a FICO score of at least 620. However, it’s possible to qualify for an FHA loan with a score as low as 500, provided you make a 10% down payment. Normally you need only a 3.5% down payment for FHA financing.
The longer you wait after bankruptcy, the more likely your mortgage application will be accepted.
That’s because waiting gives you time to:
Rebuild your credit score, which could help you qualify for a better mortgage interest rate.
Save a bigger down payment. Some mortgages, such as USDA loans or VA loans, could potentially be 100% financed. However, the less you have to finance, the less interest you’ll pay during the life of the mortgage.
Research special deals. For example, the “Good Neighbor Next Door” program provides a 50% discount on home prices in certain areas for teachers, law enforcement, and firefighters/EMS personnel. And some banks, credit unions and housing nonprofits offer first-time homebuyer programs and other benefits.
Single mom Alison Willis had been renting for years in Anchorage, Alaska, where homes are very expensive. The nonprofit Cook Inlet Housing Authority offered her a low-interest “down payment assistance loan” of $50,000 and Willis financed the rest through a local credit union.
“Because of my big down payment, I didn’t have to get private mortgage insurance,” says Willis, an elementary school teacher and mother of two. She pays $1,587 a month for the two loans on her three-bedroom, one-bathroom house.
How can you position yourself to get a better loan interest rate and more options? By waiting.
“I’ve had people ask me, ‘I’ve declared bankruptcy – how soon can I get a loan?’ I say ‘You’ve missed the point,” says Griffin.
The point isn’t to get credit again right away, he notes, but rather to rebuild your finances and learn solid money habits. Bankruptcy helps people get started on a better financial path – but it’s “a long path.”
“It’s not a miraculous restoration,” Griffin says. “It takes time to recover financially.”
The good news: The bankruptcy will have less of an impact as time goes on. It’s impossible to say how long it will take, since every situation is different.
However, the sooner you add positive information to your credit report, the sooner the bankruptcy will cease to matter quite as much.
Some ways to do that:
Bankruptcy might hurt for a while, but today is not forever.
Take positive steps to rebuild your bad credit, and research all your options before seeking any kind of loan. You could save literally thousands of dollars of interest that way – and those dollars could be used to help you reach your financial dreams.
Longtime personal finance writer Donna Freedman lives and writes in Anchorage, Alaska.