Bankruptcy is a legal proceeding for an individual or business that has been judicially declared unable to pay their debts. Filing for bankruptcy financially and legally legitimizes the debtor’s insolvency and helps create an official repayment plan for the debtor. The debtor may be able to make payments using nonessential assets or other income streams.
There are a few ways to file bankruptcy, but this article will focus on Chapter 7 and Chapter 13 as these are some of the most common types of bankruptcy filed. If you’re self-employed or work in an industry where Chapter 7 or Chapter 13 may not apply, you may have other options, such as Chapter 11 or Chapter 12 bankruptcies instead. Consulting a qualified financial expert for more information may be helpful.
How does bankruptcy affect your creditworthiness?
Bankruptcy may have a significant effect on your creditworthiness. When you file, you’re officially declaring your inability to pay off a major of your debts. Filing bankruptcy may lower your debt-to-income (DTI) ratio by nullifying some or all of your debt, but DTI isn’t the main culprit of credit score decline. Missed payments, debts in collections and the bankruptcy filing itself can all negatively your credit score. This can remain on your credit report for seven years, and, in some cases, up to 10 years.
As you might know, lenders check your credit history when evaluating your loan application. So, how does bankruptcy affect your ability to take out a mortgage? There isn’t one single, straightforward answer. It largely depends on the type of bankruptcy you file and how you plan on rebuilding your credit, so try not to count yourself out of the mortgage game just yet.
Can you get a mortgage after filing for bankruptcy?
Bankruptcy doesn’t exempt you from getting a mortgage, but it might make it a little more challenging. A bankruptcy discharge is a court order that releases a debtor from any obligation to repay certain debts. Depending on the financial institution, it can take anywhere from one to four years after your bankruptcy discharge to become eligible to take out a mortgage. Additionally, it typically takes time to rebuild your credit enough to qualify for the mortgage you may want.
Your eligibility may also depend on what type of bankruptcy you filed for:
Filing Chapter 7
Chapter 7 bankruptcy is the most common way to file bankruptcy. The process often involves a government liquidation of your assets to pay off your debts. Eventually, any remaining debt may be discharged, but you’re typically responsible for paying as much of the remaining debt as possible.
If you’re applying for a conventional mortgage, you may need to wait at least four years after your discharge date. On the other hand, you may be eligible for an FHA or VA loan after only one to two years from the discharge date depending on the financial institution and whether you meet the remaining qualifications for those loans.
Filing Chapter 13
Chapter 13 bankruptcy is another common way to file. The repayment plan is typically structured to give you a certain term to pay back the debts, using payment increments by your income.
For a conventional loan, you may wait two to four years depending on how much you’ve paid or if your debts have been discharged. If you’re applying for a different type of loan, like an FHA or VA loan, it’s typically about 12 months, you’ll likely also need permission from the bankruptcy court and your mortgage lender to apply for the mortgage in the first place.
Although filing for bankruptcy may make getting a mortgage more complicated, it’s not impossible. the necessary period, rebuilding your credit in the meantime and working with your lender may help you qualify.
Tips for improving your credit after bankruptcy
Improving your credit score after bankruptcy might feel overwhelming — like it’s hard to know where to start. By implementing a few savvy habits to support your financial health, however, you’ll likely be headed in the right direction. For example:
- Making payments to other debts: Making consistent, payments is one way to improve your credit after bankruptcy. It may be for a credit card, car loan or even student loans — any debt consistently paid off on time can be helpful toward your credit.
- Maintaining low credit: a low credit rate means using a smaller percentage of your available credit. For example, if you have a $10,000 credit limit and have a $7,000 balance monthly, you have a 70% rate. To improve your credit, reducing your credit spending to $5,000 would lower your rate to 50%. This could possibly make you appear less risky to lenders.
- Applying for other forms of credit and making payments: If you currently don't have any forms of healthy credit, it may be beneficial to consider applying for new credit options to a positive credit history. For example, a new credit card or small personal loan that you know you can pay off on time. Building a healthy, diverse credit history is important to your credit after bankruptcy.
- Fixing errors in your credit report: Fixing any errors in your credit report may help improve your credit after bankruptcy. By disputing any false discrepancies, you can ensure your credit history is being reported correctly.
In summary
While getting a mortgage after bankruptcy might take some time, it is possible. Your mortgage candidacy will depend on what type of bankruptcy you’ve filed, how your lender handles bankruptcy and mortgages and, finally, how long it takes to build up your credit score. Making payments to other debts, a low credit ratio and fixing errors in your credit report to support your credit score may help your mortgage eligibility. Consider speaking with a bankruptcy lawyer and tax consultant to help determine what next steps may be best for you.
