A bankruptcy proceeding can reduce or even eliminate your debts, but it will damage your credit report and credit score in the process, which can affect your ability to obtain credit in the future for things like new credit cards, a car loan, and a home mortgage. The good news: Even though it will take some time to rebuild your credit, it is possible to buy a house following bankruptcy. Here’s how.
First Things First: The Bankruptcy Discharge
To even be considered for a mortgage loan request, the bankruptcy must first be discharged. A bankruptcy discharge is an order from a bankruptcy court that accomplishes two important things:
- It releases you (the debtor) from any liability on certain debts;
- It prohibits creditors from attempting to collect on your discharged debts.
In simple terms, this means that you don’t have to pay the discharged debts, and your creditors can’t try to make you pay. A discharge of your debts is just one step in the bankruptcy process and, while it doesn’t necessarily signal the end of your case, it is something lenders will want to see. Often, a bankruptcy case is closed by the court shortly after the discharge.
Check Your Credit Report
Lenders look at your credit report – a detailed report of your credit history – to determine your creditworthiness. Although bankruptcy filings can remain on your credit report for up to 10 years, it doesn’t mean you have to wait ten years to get a mortgage. You can speed things up by making sure your credit report is accurate and up to date. It’s free to check: Every year, you are entitled to one free credit report from each of the “big three” credit rating agencies – Equifax, Experian, and TransUnion. A good strategy is to stagger your requests, so you get a credit report every four months (instead of all at once). That way you can monitor your credit report throughout the year.
On your credit report be sure to watch for debts that have already been repaid or discharged. By law, a creditor cannot report any debt discharged in bankruptcy as being currently owed, late, outstanding, having a balance due, or converted as some new type of debt (e.g., having new account numbers). If something like this appears on your credit report, contact the credit agency right away to dispute the mistake and have it corrected.
Other mistakes to look for:
- Information that is not yours due to similar names/addresses or mistaken Social Security numbers
- Incorrect account information due to identity theft
- Information from a former spouse (that should no longer be mixed with your report)
- Outdated information
- Wrong notations for closed accounts (e.g., an account you closed that appears as closed by the creditor)
- Accounts not included in your bankruptcy filing listed as part of it
Rebuild Your Credit
If you want to qualify for a mortgage (For more, see: Five Steps To Scoring A Mortgage), you’ll have to prove to lenders that you can be trusted to repay your debts. After a bankruptcy, your credit options may be fairly limited, but two ways you can start rebuilding your credit are secured credit cards and installment loans.
A secured credit card is a type of credit card backed by the money you have in a savings account, which serves as collateral on the card’s credit line. The credit limit is based on your previous credit history and how much money you have deposited in the account. If you fall behind on payments (which you should avoid at all costs since you’re trying to prove you can repay your debt), the creditor will draw from the savings account and reduce your credit limit. Unlike most debit cards, the activity on a secured credit card is reported to the credit agencies, which allows you to rebuild your credit.
Installment loans are loans on which you make regular payments each month that include a portion of the principal, plus interest, for a specific period. Examples of installment loans include personal loans and car loans. Of course, it goes without saying that the only way to rebuild your credit with an installment loan is to make your payments on time and in full every month. Otherwise, you risk damaging your credit even further. Before obtaining an installment loan, be certain that you will be able to service the debt.
The Bottom Line
It is possible to buy a house after bankruptcy, but it will take some patience and financial planning. It’s important to check your credit report regularly to make sure everything is there that should be – and nothing is there that shouldn’t be. You can start to rebuild your credit using secured credit cards and installment loans, making sure that all payments are made on time and in full each month.
While you may qualify for a mortgage sooner, it’s a good idea to wait two years following the bankruptcy since you’ll likely get better terms, including a better interest rate. Keep in mind that even a small difference on an interest rate can have a huge effect on both your monthly payment and the total cost of your home. If you have a $200,000 30-year fixed-rate mortgage at 4.5%, for example, your monthly payment would be $1,013.37, and your interest would be $164,813, bringing the cost of the home to $364,813. Get the same loan at 4%, and your monthly payment would drop to $954.83, you’d pay $143,739 in interest, and the total cost of the home would drop to $343,739 – more than $21,000 in savings because of the 0.5% change in interest.