Unsecured Loans after Bankruptcy: What You Need to Know
In the past, financial difficulties caused you to file for bankruptcy. You’re hoping creditors can see beyond this because you’d like to take out an unsecured loan. Also known as personal loans or signature loans, unsecured loans allow you to borrow money without putting up collateral — i.e., your home or car.
This might sound ideal if you don’t own any significant assets or don’t feel comfortable putting them at stake. But without collateral, unsecured loans pose a greater risk to lenders. They tend to have higher interest rates and a higher credit score requirement.
Can consumers get unsecured loans after bankruptcy? The short answer is yes, though it may take some time and effort — after all, bankruptcies do have a negative impact on credit ratings. Probably more difficult than getting approved for financing is finding a loan without super-expensive and burdensome terms. That will take some effort.
Getting an unsecured personal loan (and making all payments on time and in full) can help rebuild your credit after discharging a bankruptcy. The right planning and preparation before applying, so you can present the strongest application possible, may help you get a better deal on a post-bankruptcy loan.
Can you get an unsecured loan after bankruptcy?
It might be possible to get an unsecured loan post-bankruptcy, but it probably won’t be easy. Several factors will determine your eligibility, including:
Type of bankruptcy filed
When you filed for bankruptcy, you likely took one of the two most common paths: Chapter 7 or Chapter 13. The form of bankruptcy you chose could impact your eligibility for an unsecured loan.
Chapter 7 bankruptcy is also known as a liquidation bankruptcy. Most of your property is sold to repay creditors. People with low incomes who are unable to repay some or all of the debt they’ve incurred typically take this option.
In a Chapter 13 bankruptcy — i.e., a reorganization bankruptcy — you’re usually allowed to keep your property if you complete a court-ordered repayment plan. This gives you the opportunity to catch up on payments for secured assets, with the possibility of having some unsecured debts discharged.
A Chapter 7 bankruptcy can stay on your credit report for up to 10 years, while a Chapter 13 bankruptcy is erased after a maximum of seven years. When a bankruptcy is listed on your credit report, it has a negative impact on your credit score. But it holds less weight over time.
How recently you filed bankruptcy
Generally speaking, debtors have to start rebuilding their credit slowly, said Gregory Germain, a professor of law at Syracuse University College of Law.
“If the debtor has a good job, they may be able to get an unsecured credit card with a small credit line shortly after filing bankruptcy,” said Germain, who also serves as founder and director of the university’s Bankruptcy Clinic, which represents low-income debtors. “If the debtor has a poor credit history before filing, then it will be harder to re-establish credit.”
If possible, you might want to wait awhile and let your credit score heal after bankruptcy, said Jeffrey Arevalo, an expert at GreenPath Financial Wellness, a national nonprofit that helps people overcome financial crises, including bankruptcy. Since a bankruptcy typically removes your credit history from your credit report, he said it could be difficult for lenders to assess your creditworthiness.
“A bankruptcy can also last up to 10 years on your credit report, so this could be seen as a red flag by the lender when it comes to approval for an unsecured loan,” Arevalo said.
But if you need an unsecured loan shortly after bankruptcy, Arevalo said it’s possible to get one. If you take this route, beware of predatory lenders, as he warned they tend to target people fresh out of bankruptcy since you might be in a more vulnerable position. He said he often advises his clients to show new credit activity as a way to rebuild credit after bankruptcy.
“A next step towards this may be communicating with your bank or credit union that you trust to identify if they may offer some credit rebuilding tools, such as a small personal loan that you can pay back over a few months to help with rebuilding your credit history,” Arevalo said.
Current credit score
Germain said developing better money management habits after bankruptcy is the most important way to rise above it. If you never charge more on the card than you can repay at the end of the month and make all your payments on time, he said you’ll be able to get credit increases and rebuild your credit.
“I have clients who a few months after filing were able to get an unsecured credit card, and a few months later qualified for a car loan,” Germain said. “So it can be done pretty quickly, and by developing proper money management habits, they will be able to develop an excellent credit score.”
This is key, as he said your credit score is really the only thing that matters when it comes to determining eligibility for an unsecured loan after bankruptcy.
When you fill out your application
1. Have your personal contact details handy
A lender wants to know who it’s working with, so you’ll be required to provide basic contact information. Every application is different, but plan to share your Social Security number, date of birth, citizenship status, email address, primary phone number and permanent address.
2. Provide proof of income
You can’t expect to be granted an unsecured loan without providing proof that you have the means to pay it back. Prepare to share information on your employment status, work phone number, employer name, gross monthly income — and the sources from which it comes — and the amount of your monthly mortgage or rent payment.
3. Decide on your loan terms
Before completing the application for your unsecured loan, you’ll need to decide the amount of money you need and your desired terms, among other things.
4. Provide additional documentation
You might be asked to provide additional documentation. Gather recent pay stubs or W-2 forms, utility bills and your driver’s license. It’s possible you’ll be asked to share even more paperwork, so don’t be surprised.
If your application is approved
1. Compare loan offers
“Check the fine print,” Arevalo said. “Most loans that consumers can qualify for after bankruptcy tend to carry very high interest rates, some of which can be over 30%.”
He noted that higher interest rates mean you’ll be paying a lot more over the life of the loan, which could make it more challenging to pay off due to the larger monthly payment.
When reviewing loan offers, carefully compare interest rates, fees and APR. Check the next step for more on fees.
2. Review fee information
It’s not uncommon for extra fees to be tacked onto unsecured loans, which can significantly increase your financial obligation. Origination fees and prepayment penalties are two common costs that borrowers regularly face.
Often charged to process a loan application, an origination fee can be a percentage of the total value of the loan or a flat rate. It might be taken from the full loan amount and absorbed into the APR. No matter how it’s presented, it’s important to calculate this fee into the total amount of your loan so that you’re granted the correct amount.
Some lenders also charge a prepayment penalty for paying off your loan early. It’s important to know this information in advance if you think you might want to take this route.
3. Calculate the total cost of the loan
An unsecured loan is a major financial obligation, so make sure you can afford the monthly payments. Add up all the costs associated with each loan offer you’re considering to see exactly what you’re getting into. Do not proceed if you’re not sure you can make all monthly payments by the due dates.
Rebuilding Credit with an Unsecured Loan
While rebuilding your credit, there are a few points to keep in mind. Lenders that target consumers fresh out of bankruptcy do it for a couple of reasons – first, you won’t be allowed to file again for many years, so the lender can be reasonably confident that if you have the income to make the payment, you will repay your loan. Second, lenders that focus on the newly-bankrupt know that these borrowers are grateful to be approved for anything and are less likely to be picky about their terms. According to the Fed, “In credit card industry parlance these individuals are referred as “cash cows” because they generate high income and profit margins, usually from high interest rates and fee income…”
3 alternatives to an unsecured personal loan if you’re rejected
If you have collateral to put up, you might be able to get a secured loan. Since your loan will be backed by an asset — i.e., your home or car — you’ll likely be able to score a lower interest rate. This option poses an added risk to you because if you default on the loan, the lender will take possession of your collateral. Do not choose this option if you’re at all uncertain of your ability to make on-time payments.
Secured credit card
Unlike the traditional version, a secured credit card requires you to pay a refundable security deposit. If you’re unable to get approved for a standard credit card, this could be a good option. Having a credit card post-bankruptcy might make you weary. But, when handled properly, it can be a positive experience.
“If you pay your balance in full each month, a credit card will help you build better credit, will serve as a safe and convenient method of payment and, eventually when your credit score improves, the credit card company may pay you to use your card with rebates and travel rewards,” Germain said. “But it requires you to be responsible.”
He emphasized that having a credit card requires you to be accountable for your spending. So if you don’t trust yourself, choose another alternative.
Payday alternative loan
If you’ve belonged to a credit union for at least a month, you might be eligible for a payday alternative loan (PAL). Available in increments from $200 to $1,000, a PAL must be repaid within one to six months. Credit unions are only permitted to assess a maximum $20 application fee, covering only the cost to process your application. If you’re considering a payday loan, this is a better option.
Getting an unsecured loan after bankruptcy is possible, but largely dependent on many different factors. If a lender is willing to grant you an unsecured loan, do proper due diligence to make sure it’s a competitive offer that fits your budget. It’s important to realize there are several other alternatives. Don’t get yourself in another situation that puts your finances at risk.