“‘How did you go bankrupt?’ Two ways. Gradually, then suddenly.”
Going into bankruptcy is no fun. But sometimes it happens, and if it does it’s important to understand what you can do to minimize its impact on your life once you’re discharged. When it comes to getting a mortgage after bankruptcy, all is not lost.
But you have to know what to do.
The Rule of Two’s
The rules for establishing credit, which is basically an institutional metric used to determine how trustworthy you’ll be with someone’s money, are the same for people that have declared bankruptcy as for those that haven’t.
In order to secure a mortgage, you’re going to have to reestablish at least two lines of credit, preferably the day after you’re discharged.
The Rule of Two’s goes something like this: In order to establish a credit history, you need to have two lines of credit (credit cards, loans, etc.) with a limit of a minimum of $2000 each, for at least two years.
Without two years of history, lenders are very unlikely to even consider your application for a mortgage after a bankruptcy. Even if you hadn’t declared bankruptcy, not having at least two years worth of credit history leaves your credit report thin and doesn’t give a prospective lender much to go on.
Mortgage lenders are often conservative with their lending practices, that’s how they protect their assets. So unless you are open to working with an alternative lender (and most alternative lenders wouldn’t consider your application at this point either), reestablishing your credit history with the Rule of Two’s is a must.
Saving a down payment
Lenders want to see that you’ve learned your lesson. They don’t want to get burned, so coming to the table with less than a 10% down payment is likely to get you declined.
In addition to cleaning up your credit history, setting aside some savings is an important step in getting a mortgage. The risk to a lender of a borrower defaulting on their mortgage is approximately halved when the down payment goes from 5% to 10%, so saving 10% is the goal you should be aiming for post-bankruptcy.
Staying on track
An important tip to remember when reestablishing your credit after bankruptcy is that you don’t need to maintain a balance in order to build up your credit.
A common misconception with credit cards is that to see an improvement on your credit report you need to maintain a balance, which is untrue. The only thing you need to do is make sure you use them at least once a month.
It doesn’t matter what the dollar amount of the purchase is, as long as a transaction occurred your credit history will show positive progress.
Another tip to keep in mind is to keep your balances below 50% of your credit limits.
As we’ve covered in a previous article, which you can find here, carrying high balances is a factor that actually reduces your credit score each month. You could be making your payments on time each month and still be affected negatively.
Keeping your balance below the 50% mark is a sign of financial discipline that lenders look for to make sure you are a trustworthy borrower.
Since we’re on the topic of credit reports, it’s also a good idea for you to request your credit report from Equifax and TransUnion once you’re discharged. Many borrowers have mistakes on their credit reports, even after being discharged, because lenders sometimes forget to remove their claim from the report.
This could lead to your credit report showing that you still owe money on a debt that doesn’t exist anymore.
Which will obviously hurt your ability to get approved for a mortgage.
So it may take some effort on your part to reestablish credit post-bankruptcy, but it certainly isn’t a lost cause. In many ways, you’re starting from scratch and the same financial strategies that someone just getting started in building their credit will work for you as well.
Don’t wait to start rebuilding your credit once you’re discharged, especially if you want to apply for a mortgage in the future. As we like to say, the best time to start something is 20 years ago. The second best time is now.