Although many people fear the negative stigma associated with bankruptcy, sometimes it may be the only "make sense" option to recover from a financial crisis. However, many of the general rumors about Bankruptcy are overblown, such as the notion that it will "ruin your credit" for 7-10 years. The truth is that although a bankruptcy will stay on your credit report for a long time (7 years for a Chapter 13 and 10 years for a Chapter 7), it's quite possible to build your credit back up to a range that's acceptable to qualify for a mortgage and even obtain what most lenders would consider a "good" credit score in as little as two years. Furthermore, it may be possible to qualify for an FHA loan with an active Chapter 13 Bankruptcy as little as 12 months after establishing a repayment plan.
Here's a summary of FHA guidelines to obtain a loan while in a Chapter 13 Bankruptcy:
- Borrower must have made at least 12 on-time payments to the Bankruptcy trustee.
- The Bankruptcy Trustee must APPROVE the purchase of a new home (or refinance).
- The borrower must have a good payment history on accounts that are not included in the bankruptcy.
- All other guidelines to obtain an FHA loan must also be met.
I'm not an attorney or an expert on what a Bankruptcy Trustee will approve, other than to say it must generally "make sense".
Furthermore, many lenders will require each borrower to have at least a minimum median credit score of 580-620. Although FHA does not specifically have a minimum credit score, virtually every lender has their own minimum requirements.
In addition to these general requirements, lenders will expect to see some additional credit references besides just paying the Bankruptcy on time. FHA requires a minimum of three credit references that have been open for at least 12 months and that have had some kind of activity within the last six months. Borrowers that don't have three credit references that report to the credit bureau may use alternative references in some cases, such as rental history, insurance and utility payments and/or other accounts or lines of credit that are paid monthly. However, I strongly recommend maintaining at least three open and active tradelines for people that have had past bankruptcies since it takes rebuilding some good credit to offset past bad credit. Also, most accounts that are included in Bankruptcy will be closed once the BK is completed. Without establishing new credit, the credit score may remain very low for a long time. A good alternative may be to obtain one or more secured credit cards.
If you are contemplating filing Bankruptcy, seek advice from a competent attorney and review your options. It may also be a good idea to speak with a mortgage lender for advice on how to structure your debts to obtain the maximum long term benefit for both your net worth and credit score. While credit score is important, it's also something that can be repaired with time.