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Ask Dr. Don

Rebuilding credit after a Chapter 13 bankruptcy

Dear Dr. Don,
I have been discharged from my Chapter 13 bankruptcy for seven months. I want to get a personal loan for about $5,000 to re-establish my credit. What is the best way to do this? I would like to write a letter explaining why I had to file a Chapter 13, but I need some help writing it.
Darlene Document

Dear Darlene,
Congratulations on completing your Chapter 13 repayment plan and the subsequent discharge of any remaining eligible debts by the bankruptcy court. According to Nolo.com, only about 35 percent of those filing a Chapter 13 bankruptcy petition successfully complete their repayment plan.

With the exception of a Chapter 7 bankruptcy filing that stays on your credit report for 10 years, negative information stays on your credit report for seven years. A Chapter 13 repayment plan lasts from three to five years so your negative information is aging nicely but you won't have to wait for the information to drop off before you can qualify for credit.

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Under provisions of the Fair Credit Reporting Act, you can include a letter of explanation in your credit report when you've disputed an item in your credit report and the dispute wasn't resolved in your favor. That doesn't describe your situation so you won't be able to include an explanatory note in your credit report.

With a bankruptcy filing on your credit report you are a "story" credit. That means that you will have to sell the lender on your story before they'll consider loaning you money. While putting your thoughts to paper is a good way to distill what happened into a few paragraphs, I'm going to discourage you from including the letter with any loan applications. It's not likely to tip the scales in the loan decision and it becomes part of the file on the account.

Be selective about where you apply for credit. Don't fill out a lot of loan applications because every application will show up on your credit report as a loan inquiry. An inquiry will stay on your credit report for two years. The more times you are rejected, the harder it becomes to get the next lender to say yes. Put together a plan. Start out by getting a copy of your credit report and credit score. Bankrate provides contact information for all three credit bureaus. Also take a look at Bankrate's "13 things you never knew about your credit report."

Look at your existing financial relationships and, if they offer personal loans, guesstimate whether the relationship is strong enough that they would be willing to loan you $5,000. Talk to a loan officer personally before filling out a loan application. If you are eligible for membership in a local credit union, that would be a good place to start shopping for a personal loan.

Getting a $5,000 personal loan and showing a consistent repayment history will help you rebuild your credit. How are you going to spend the $5,000? (Trick question -- you should keep the money in a savings account and pay down the loan over time from the account balance.)

If you can't get a conventional loan, then consider a secured deposit loan or a secured credit card. What I like about either of these approaches is that it shows that you have the financial discipline to live within your means plus raise the deposit. The deposit is the loan's collateral, so the lender isn't taking on a financial risk and you can generate a repayment history for your credit report.

-- Posted: June 4, 2003

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See Also
The basics of bankruptcy
10 ways to bounce back from bankruptcy
Financial advice glossary
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