“‘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
Establishing credit is an institutional metric that determines how trustworthy you will be with someone’s money regardless of whether you declare bankruptcy or not.
In order to secure a mortgage, you’re going to have to re-establish at least two lines of credit.
The Rule of Two’s goes something like this. In order to establish a credit history, you need to have two trades (credit cards) with a limit minimum of $2500 each for two years.
Without two years of history, lenders are very unlikely even to 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), re-establishing 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
A vital tip to remember when re-establishing your credit after bankruptcy is that you don’t need to maintain a balance 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.
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.
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.
Cut The Time It Takes To Refinance Your Mortgage In Half
Clients that have their documents ready to go can potentially save weeks getting their mortgage approved.
So it may take some effort on your part to re-establish 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.