*This post was published in 2005. Bankruptcy guidelines have changed greatly since then. For more information, check out the government’s website here.
The good news: Having a bankruptcy on your credit report does not mean you can’t buy a home. Believe it or not, those who have gone through bankruptcy are actually encouraged to find ways to build credit by taking on debt.
The bad news is that debt will be closely scrutinized, come in smaller amounts, and have higher interest rates because lenders will consider them to be higher-risk borrowers. But these downsides shouldn’t discourage those with poor credit history from investigating their home loan options. The responsible use of credit is the only way up from a bankruptcy filing.
How Bankruptcy Affects Your Credit Rating
Bankruptcy can provide relief to people in dire financial straits by releasing them from the obligation to repay their debts. It’s a drastic move for anyone because a bankruptcy will stay on a person’s credit rating for up to 10 years, effectively acting like a warning flag to anyone considering lending that person money or a line of credit.
In order to mitigate the risk of providing that person a loan, the lender will charge higher interest rates than they normally would. For instance, an auto loan that might ordinarily carry six percent interest could come with an interest rate of eight percent or higher. But, as time passes and small loans and credit card balances are paid off on time, the bankruptcy filing becomes less and less significant to a lender.
Rebuilding Good Credit After Bankruptcy
Establishing good credit after bankruptcy is essential. The following will help recent bankruptcy filers regain their financial strength:
- Pay bills on time. This is the single best thing bankruptcy filers can do to build up their credit rating.
- Acquire and use a secured or unsecured credit card. Just don’t charge any more than you can afford to pay off each month.
- Read your credit report. Errors are possible, and keeping tabs on your progress will help you stay focused on the goal of rebuilding after bankruptcy.
When and How to Find a Home Loan
Understandably, mortgage companies want some form of reassurance that the borrower is on a safe and responsible financial track. Many lenders prefer to see three things when considering loaning money to someone following a bankruptcy:
- A two-year stretch of on-time bill payments
- A down payment
- A steady income
The one non-negotiable item on the list is a reliable income. The other two – two spotless years of credit and a down payment – aren’t quite set in stone. Some lenders will be willing to provide a loan sooner than two years if there is evidence of responsible bill payment on a car or secured credit card plus reliable income.
Likewise, with a steady work history and a down payment (even a small one), it’s not impossible for someone just coming out of bankruptcy to secure 100-percent coverage on a home loan.
Finding a reputable lender willing to loan a home’s total value to someone just beginning the process of rebuilding their credit, and with an on-again off-again employment situation, is a tall order, and probably not a good idea for the would-be borrower. Post-bankruptcy borrowing should be undertaken at a slow pace and with an eye toward the future. With proof of responsible borrowing and spending, home ownership won’t be far off.