Filing for bankruptcy clears many of your personal financial obligations, but it also places you in credit purgatory. Whether you declare Chapter 7 or Chapter 13, bankruptcy leaves a stain on your credit profile that will stay with you for up to 10 years. But you don’t have to wait 10 years to rebuild your credit. A personal loan, especially from your local credit union or an online lender, can be a powerful tool to help you regain your financial footing and rebuild your credit.
Tip: Using personal loans to rebuild your credit history is a two-edged sword. Although making regular payments on a personal loan can help, taking on debt can be expensive and push you into deeper financial difficulties. Take a reality check before purchasing a personal loan and make sure you can afford the monthly payments.
Build Favorable Credit History with On-Time Payments
According to MyFICO.com — the company behind the most commonly used credit score by lenders — your payment history is the single largest factor in calculating your FICO score. A whopping 35 percent of your score is determined by how promptly you pay your bills. By taking a personal loan with lenders that report to major credit reporting bureaus, such as NetCredit or Rise, you can nudge your credit score in the right direction. Why? Personal loans are repaid over months or years, which gives you plenty of time to establish a pattern of on-time payments.
Tip: If you do decide to get a loan to help your credit score, avoid payday loans. They don’t report to credit bureaus and will do nothing to rebuild your credit.
Give Yourself A Loan
The drawback of using a personal loan to improve your credit is you may be tempted to buy things you cannot afford. You can minimize the cost of a personal loan by investing the funds in a secure investment instrument, such as a CD, and use the loan as a tool to save money.
Captian Money Tip: Notice the interest you pay on the loan will exceed the income you generate from the CD. This is not a good investment idea. The primary goal (and only potential benefit) is to build a positive payment history.
Many banks and credit unions will provide loans secured by CDs. The money you borrow is deposited directly into the CD account while you make payments on the loan each month. You are essentially borrowing from yourself. This option is great for lenders because there is no risk for them. After you have repaid the amount of the loan, plus whatever interest is charged, the bank releases its hold on your CD. Once your CD matures, you receive earned interest along with your original deposit. In the meantime, your bank or credit union reports your on-time payments to the three major credit reporting agencies, which could help your credit score.
If your bank or credit union doesn’t offer CDs, or if you cannot qualify for a bank or credit union loan, do not despair. You can obtain a personal loan and use the money to purchase a CD from any financial institution that you choose. If you get your loan through an alternative lender, make sure they report to at least one credit bureau.
Obtain A (Secured) Credit Card
Many people choose to live without a credit card after bankruptcy. But everyday activities, such as renting a car or booking a hotel, can be difficult without a credit card. If you qualify for an unsecured credit card after filing for bankruptcy, the terms you receive will be less than desirable: low credit limits, stiff fees, and high interest rates.
Secured credit cards, such as First Progress Platinum Elite Mastercard, USAA’s Platinum Mastercard (only for members of the armed forces and their families), look and work like regular credit cards but are available to people with poor credit. Also, they usually offer lower interest rates and few or no fees because the credit limits are
dictated by the guarantee deposit you provide.
However, if you just filed for bankruptcy, you probably don’t have much cash lying around to deposit as a guarantee. A personal loan allows you to obtain the cash you need to make a substantial deposit and receive a reasonable credit limit of $1,000 or $1,500.
Captian Money Tip: Credit score algorithms also look at your debt-to-available-credit ratio. In fact, credit utilization accounts for 30 percent of your FICO score. Once you have a credit card, you could further improve your credit score by maintaining low balances on your secured credit cards.
Qualify for Better Credit Offers
None of these methods are quick fixes for your credit. Don’t trust people or companies who claim they can remove all negative items on your credit report. Although incorrect items can be deleted from your credit profile, there’s no way you’re removing legitimate items, such as a bankruptcy. The best approach is to ensure that there are no errors in your credit report and rebuild your credit profile with regular and on-time payments, such as loans or credit card payments. Expect to see improvements in your score after about six months to a year.
If you do decide to get a personal loan, stick with lenders that offer competitive rates, consider borrowers with poor credit, and report payments to credit bureaus. Of course, obtaining a loan is not the only or the best way to rebuild your credit score. Consider talking to a credit specialist about your options.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.