Sometimes filing bankruptcy is unavoidable, and one of the downsides is that it remains on your credit report from seven to 10 years—potentially affecting your ability to purchase a home.
Robert Satnick, residential president of the California Mortgage Brokers Association, says, "It’s going to become increasingly more difficult to obtain credit over the next few years, particularly if you’ve filed for bankruptcy.”
Individual Bankruptcy at a Glance
The most common forms of individual bankruptcy are Chapters 7 and 13 of Title 11 of the United States code. With Chapter 7, known as liquidation or straight bankruptcy, some of your property is sold by the trustee who applies the sale proceeds to your debts. In Chapter 13, or reorganization, you pay back the money you owe in monthly installments over a three- to five-year period.
Not all debts are settled or discharged in bankruptcy—child support, student loans, alimony and liens like the ones on vehicles are still your responsibility.
But that’s not necessarily a bad thing. By keeping current with these obligations, you show lenders you take all of your debts seriously, which will help re-establish your credit.
Monitor Your Credit Report
After bankruptcy, reestablishing yourself as a good credit risk is essential. The first step you should take is reviewing your credit report.
"Make sure there’s nothing wrong on it and you’re not shown with a delinquent balance even though you paid the bill on time," says Andrew Housser, founder and co-CEO of Bills.com, a consumer financial education web site. Pay close attention to those debts that were discharged in bankruptcy, making certain they show up on your report as “closed.”
The Fair Credit Reporting Act gives you the right to check your report for free once a year. Challenge any errors you find with the credit reporting agency by notifying them in writing. All three credit reporting agencies provide directions for disputing information on their respective web sites: Equifax, Experian and TransUnion. You’re required to have a copy of the credit report they issued prior to filing disputes. You’ll need the details surrounding the disputed item, including cancelled checks, account numbers, correspondence, notes, warranties and guarantees.
AnnualCreditReport.com, cosponsored by all three credit reporting agencies, has step-by-step instructions for obtaining a copy of your report by applying online, phone or mail. It takes about 15 days to process your request.
These credit reporting agencies collect information on what you make, where you work and live, how much you owe to lenders and your bill paying habits and then assign you a FICO score. Developed by Fair Issac & Co., FICO scores are used mostly by mortgage bankers to determine the likelihood that a borrower is a good risk. All credit scores involve statistical analyses of an individual’s credit history.
The highest FICO score is 850. A score of 620 or below makes obtaining future credit very difficult. Bankruptcy alone knocks 200 or more points from your score.
Establish New Credit
If you’ve lowered your credit score through bankruptcy, you must bring it up to be approved for a home loan. Start the process by rebuilding your credit. It sounds counterintuitive, but a good place to start is with credit cards.
In the past, bankruptcy didn’t keep most people from obtaining new credit cards, but the rising number of defaults on loans and credit cards will probably change all of that. Keep your debt to credit ratio low, which means not exceeding 30 percent of your available credit. For example, you should not charge more than $1,500 on a card with a $5,000 credit limit.
"If you are only making $3,500 a month and have three credit cards and you’ve charged them up to $25,000, then you’re just going down the same road," Satnick says.
Having too many credit cards won’t work in your favor, either, but it’s better to have two or three cards with small balances than one card with a large balance. And don’t cancel cards even if they’re paid off and you don’t plan to use them. Access to available unused buying power makes you a better credit risk.
If you can get a new, unsecured card, expect to pay a significantly higher rate of interest. A secured credit card offers another option. They work a lot like gift cards because you pay money up front before you use them, and your expenditures are deducted from the balance.
As a rule, secured cards carry low balances, usually $500 or less. Like unsecured cards, use them carefully and "refill" the card regularly to keep your balance low.
Satnick says unsecured cards are not always useful because some don’t show up on credit reports. If you do opt for a prepaid card, find one that reports to the major credit reporting companies and doesn’t charge outrageous up-front fees.
Adella Jones, who lives near Durham, N.C., began repairing her credit immediately following bankruptcy. A newly single mother with two children to support, she worked hard to establish a stable employment history, rented an apartment and always paid her rent and utilities on time. Jones also bought items such as a washing machine on an installment loan and never missed a payment. When she finally qualified for a credit card, she never carried a balance. "I’d buy groceries on it, then go home and write the check to pay them off and put it right in the mail," Jones said. Eventually her hard work yielded positive results on her credit report.
In addition, Jones beefed up her eligibility with a good job. She has been steadily employed in the same field since she filed bankruptcy. A stable employment history is a factor mortgage lenders consider when evaluating you for a home loan.
While living in an apartment, Jones met a real estate agent who suggested she buy a home. When Jones mentioned her bankruptcy, the agent helped her find a lender willing to take a chance on her.
Save for a Down Payment
Terry Savage, financial expert and author of several books, including The Savage Truth on Money, agrees with mortgage banker Satnick, saying that with so many homes going into foreclosure, loan companies and banks are much warier.
"The good news is there is so much supply on the market that you should be able to rent for far less than you could several years ago, and that gives you time to save money for a down payment," Savage says. A substantial down payment—minimally 15 to 20 percent, more is better—will help persuade lenders you’re a good risk. If you find it hard to save, look into a payroll savings plan where money is automatically deducted from your paycheck.
Look for Backed Loans
Loans guaranteed by the Federal Housing Authority (FHA) are an excellent option for post-bankruptcy purchases. The loan is actually made by a lending institution with a promise by the FHA to pay the lender back if the loan goes into default.
FHA loans typically require smaller down payments. Buyers with less than excellent credit, first-time buyers and those with low incomes often qualify for FHA loans. The maximum loan amount varies from area to area.
You can apply for an FHA loan two years after being discharged under Chapter 7 and one year after discharge from Chapter 13, but your payments must be current. Most types of loans require two years elapse from the date you discharged your debts in order to qualify for a loan.
Finding a Lender
Ask friends and relatives to recommend a good mortgage broker or real estate agent. Be frank with potential lenders and let them know of your past bankruptcy filing. Satnick says that the circumstances surrounding your bankruptcy can make a difference. "Major medical bills, the death of a spouse and loss of significant income,” he says, “those carry a lot more weight (with mortgage bankers).”
The Bankruptcy Abuse and Consumer Protection Act of 2005 requires credit counseling prior to entering bankruptcy. Additionally, some banks and credit unions offer in-house programs that are free for its customers or members.
What about companies that offer to repair your credit? You can dispute erroneous credit information yourself for no charge. Credit repair companies charge to do the same thing and they cannot remove legitimate negative information on your credit report. The Federal Trade Commission’s web site offers help on choosing a credit counseling agency.
If you haven’t found a lender or saved enough for a down payment, alternatives still exist, but they aren’t easy fixes. Consider renting with an option to buy or asking your landlord to self-finance the sale, a move known in some places as a land contract. While both may be long shots, if you want to be a homeowner, having filed for bankruptcy in the past shouldn’t stand in your way.
Credit: Renovate with Tommy Mac