June 26, 2019

How Open Bankruptcies Affect Your Ability to Qualify for a Loan

Unfortunately, an open bankruptcy can make it difficult to qualify for a loan — especially for the first few years. Still, getting a business loan isn’t impossible if you’ve declared bankruptcy. Many lenders will consider your application depending on the circumstances that led to your bankruptcy and what you’ve learned from it. In this post, we’ll explain why open bankruptcies can affect your ability to procure a loan, and how you can improve your chances of qualifying in the future.

Everything You Need to Know About How Bankruptcies Affect Small Businesses:

What is Bankruptcy?

Bankruptcy laws were created to give individuals drowning in debt a fresh start. There are two main types of bankruptcy: Chapter 7 and Chapter 13. Chapter 7 is often called liquidation bankruptcy since it discharges most unsecured debt, including personal loans and credit cards. On the other hand, Chapter 13, is referred to as reorganization bankruptcy. Anyone who files Chapter 13 bankruptcy is put on a repayment plan and must pay creditors back over time. Chapter 11 and Chapter 12 are also options, though they only apply in certain situations. Though bankruptcy is typically considered a last resort for those in debt, most people who file are granted exemptions. According to an American Bankruptcy Institute study, 95.5 percent of the 499,909 Chapter 7 bankruptcy cases decided in 2016 were discharged, meaning the filer was no longer legally obligated to repay the debt.

How Bankruptcy Affects Your Credit:

In general, filing for bankruptcy erases any history of good credit and can stay on your credit report for up to 10 years. You’ll also have to report your bankruptcy filing to future employers, on medical forms, and on state government official reports. Bankruptcy also destroys your credit score. According to a major FICO scoring model, filing for bankruptcy can send your credit score as much as 200 points lower, which is enough to put even the strongest credit score into dangerous territory.

How Bankruptcy Affects Your Ability to Qualify for a Loan:

Open bankruptcies that have not yet been discharged often create problems for lenders (and borrowers) given the court’s involvement. If you’re in the process of filing for bankruptcy, it might be challenging for you to get immediate financing. While the negative impact of bankruptcy on your credit diminishes over time, you may still face headwinds when applying for a loan after the bankruptcy’s been discharged. A 2011 U.S. Small Business Administration report found that businesses with past bankruptcies were 24 percent less likely to qualify for a loan than businesses with no history of bankruptcy.

How to Improve Your Chances of Getting a Loan:

On the bright side, many lenders will consider you for a business loan, especially if your circumstances were extraordinary — for example, unmanageable medical bills or a crippling divorce settlement — and not because of poor financial management. Here’s what you can do to improve your chances of being approved for a business loan:
  • Wait until the bankruptcy is discharged: If your bankruptcy case is still open, you’ll likely have a better chance of working with lenders if you wait until it’s discharged and noted on your credit report.
  • Avoid the same mistakes: After you’ve filed for bankruptcy, it’s important that you don’t accumulate unmanageable debt again. Be sure you make all payments on time and be careful not to take on additional debts that you can’t pay down.
  • Have a strong business plan: A solid business plan is one of the top things lenders look for when evaluating your loan application. They’ll want to make sure your business is viable and that you’ll have enough cash flow to make your payments on time.
  • Attach an explanation for your bankruptcy: You’re more likely to be seriously considered for a loan if you explain the circumstances of your bankruptcy and demonstrate how your financial situation has improved. It’s usually best to keep the explanation brief and objective.
  • Find a co-signer: Lenders are likely to see you as less of a risk if you have someone with a strong credit history — for example, your spouse or business partner — co-sign your loan.

The Bottom Line

Bankruptcy is no doubt a financial setback. Still, it’s intended to be a fresh start for individuals and business owners alike. If you work hard to repair your credit and avoid the same mistakes that led to your bankruptcy, you’ll have a better chance of securing a business loan and rebuilding your future.