Debtors lament that they do not want to file bankruptcy because it is going to destroy their favorable credit score. The credit score however is often both illusory and temporary because they are actually teetering on insolvency or already insolvent. The classic example is the debtor who acquires multiple credit cards to purchase goods and services they cannot afford or to obtain cash to pay other cards. Debtors literally “rob Peter to pay Paul” in order to make minimum monthly payments. At some point credit is maxed out. Payment defaults inevitably follow and credit scores plummet.
The use of exempt assets (i.e. assets debtors can keep despite filing bankruptcy) to try and pay debts that one cannot and will never be able to repay is a big mistake. If mounting debt is faced head on and early, many, and possibly all assets, can be retained while at the same time discharging most if not all debts. It is a genuine personal financial disaster when debt that could otherwise be discharged is paid from exempt pensions, retirement accounts, savings and residences (through home equity loans). These are assets that were acquired over many years or even a lifetime which cannot easily or ever be replaced.
Chapter 7 personal bankruptcy will result in credit card companies cancelling credit cards, even those that may not have an outstanding balance. Bankruptcy will appear on credit reports with the major credit reporting agencies for 7-10 years. Credit scores will initially go down. Once a “Discharge” is granted however, creditors with “dischargeable” debts will forever be prohibited from trying to collect. After a discharge is granted, credit reports should show that the discharge was granted and debts no longer owed. An applicant for credit who has eliminated debt through bankruptcy is viewed by lenders to be a better credit risk than someone with outstanding debt simply because there will be no competition with other creditors for payment. Credit scores improve after filing bankruptcy. Like most good things in life, it takes time and a plan to obtain financial health.
Bankruptcies are filed for many reasons. Most bankruptcies are not filed because people are financially inept or scamming creditors. A high percentage of bankruptcies are the result of unfortunate and unavoidable life situations - personal or family health issues, medical debt, divorce, unanticipated loss of employment, reduction in pay etc. The reasons for filing bankruptcy should be shared with the potential lender.
Steps can be taken to restore a good credit rating and obtain credit. Showing that in the past one has, and can again, be relied upon to make regular payment of debts on time is important. If a home or motor vehicle is to be retained, it is important to display a record of having made timely mortgage and car payments before, during and after bankruptcy. This shows a potential lender that the person is reliable and diligent in making payments notwithstanding the fact a bankruptcy was filed.
John Cuccia Loan Specialist at LoanDepot.com located in Garden City, New York provides some guidance of what one can expect in trying to obtain a mortgage after a chapter 7 or 13 bankruptcy.
Conventional Loan - The waiting period for conventional loan after a chapter 13 can range between two to four years from discharge and four years after a chapter 7 or 11 discharge. Multiple bankruptcy filings within a seven year period results in a five year waiting period.
FHA loan - The waiting period for FHA financing after a chapter 7 discharge is two years. For less than two years, but not less than 12 months –if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond their control, and has since exhibited a documented ability to manage their financial affairs in a responsible manner. For chapter 13 filers there is a two year waiting period after the filing. The borrower’s payment performance must be satisfactory and all required payments must have been made on time, AND the borrower must receive written permission from the bankruptcy court to enter into the mortgage transaction. Cuccia advises (i) that lenders will not overlook the fact that bankruptcy has been filed; (ii) that during the waiting period it is best to focus on rebuilding credit scores. The best way is to pay bills on time and re-establish credit slowly. Cuccia recommends getting a secured credit card as a way to work up to an unsecured card over time. Importantly Cuccia recommends to be prepared to explain what happened to cause the bankruptcy and why it is unlikely to occur in the future. Finally the amount the borrower has for a down payment will determine which type of loan the borrower can apply and be eligible to receive.
Jonathan Rich, Director of Digital Innovation & Knowledge Management at Nassau Financial Federal Credit Union in Westbury New York, advises that his Credit Union offers a secured Visa Platinum Card with a credit line of up to $5,000 and a Savings Secured Loan product where members can borrow up to the amount of funds that they have in their Regular Savings Account, which funds are placed on hold and released as the loan is paid down. Repayment terms are up to 120 months.
Once there are any signs of financial instability a plan must be developed to preserve assets and restore financial health. A seasoned bankruptcy attorney can provide a plan, which if made early enough, could result in preservation of assets with, or possibly without, the need to file bankruptcy.