Bankruptcy allows consumers to regain control of finances by eliminating or reducing current debt. While in the long run, bankruptcy can improve your situation, the period immediately following a bankruptcy creates a situation where it is very difficult to obtain credit or refinance. You must take steps to improve your credit history prior to attempting to refinance your mortgage.
What is Bankruptcy?
Individual consumers generally file either a Chapter 7 or Chapter 13 bankruptcy. Chapter 7 erases most debt, while Chapter 13 places you on a reduced payment plan. The payment plan is designed to work within your budget, and the bankruptcy trustee will work with you to come up with a payment plan. Both Chapter 7 and Chapter 13 severely affect your credit report in a negative way; however, with time and effort the damage can be reduced.
How do I Fix the Damage?
To fix the damage caused by bankruptcy, you must obtain new credit, and manage the credit well. Until you are prepared and ready to begin to build credit, your credit report will only reflect the negative accounts associated with the bankruptcy. Knowing you want to refinance your home, will help encourage you to rebuild and manage your new credit account well. Very few creditors are willing to risk giving credit to a person right out of bankruptcy, which limits the options to secured credit cards. Begin by opening a secured credit card that reports to all three credit bureaus. Make every payment on time, and keep the balance less than 20% of the credit line. After six months, apply for an unsecured credit card with your bank or credit union. Again, manage this card well.
What About Interest Rates?
Refinancing your home is possible after bankruptcy. A good time line is two years after the bankruptcy, once you have started to rebuild your credit. You need to wait as long as possible to boost your credit score as high as possible. The lower your credit score, the higher your interest rate will be. Creditors are going to see you as a higher risk due to your bankruptcy, and you need to show the creditor that what happened that caused the bankruptcy is in the past; you have created a new history of prompt and on-time payments. A higher interest rate on a large loan such as a mortgage can cost you thousands of dollars over the life of the loan.
Who Will Refinance?
You are going to have to do some shopping around with mortgage lenders. Your current lender may be willing to refinance if you have maintained the account well since the bankruptcy. Each lender has its own underwriting criteria and may not accept anyone who has filed bankruptcy within a certain amount of years. Contact the lenders in your area, and ask to speak with a loan officer. Explain that you filed a bankruptcy, and let him know your current credit score, income and expenses. While he can’t give you any type of real answer without a formal application, he should be able to tell you if you have a chance at refinancing or if the company just doesn’t deal with someone in your situation. Be prepared to shop around. Carefully review all interest rates associated with the loans.
How Long After Bankruptcy?
There isn’t a clear-cut answer to this question. Many lenders will refinance as soon as two years following a bankruptcy discharge, but this depends on what you have done with your credit since the discharge. Have you worked on repairing your credit? Are you adding positive history monthly? Have you done nothing? A lender has to see that you have turned your financial situation around and that you can and will continue to pay. Be prepared to wait longer than two years if your interest rate will be high. By waiting an additional year, you may save a substantial amount of money in the long run.
Living in Denver, Lynndee Marooney has been writing finance and credit-related articles, guides, manuals and e-books for private companies since 1995. She holds a Bachelor of Arts in journalism and a Bachelor of Science in finance from the University of Maryland. She enjoys counseling clients who are experiencing financial difficulties.