You lost your job and could no longer afford your monthly mortgage payments. You stopped making them and lost your home to foreclosure. Maybe you've made so many financial missteps that you filed for either Chapter 13 or Chapter 7 bankruptcy protection to get a fresh start.
These are big financial disasters. Each will send your credit score plummeting by 100 points or more. And don't expect to qualify for credit cards, a mortgage loan or auto financing anytime soon.
3 Biggest Credit Busters
There is hope, though. It is possible to recover from each of these three financial disasters. It just takes time and good financial habits to boost your credit score and become an attractive borrower once again.
"A lot of times people say that they can't do anything for seven or 10 years after a foreclosure or bankruptcy," says Chris Copley, who has worked as a regional manager for TD Bank. "That's not necessarily true. If you take the steps to rebuild your credit, you might be able to get a credit card or even a mortgage loan before that seven- or 10-year period is up. Don't fall into that trap of thinking that there's nothing you can do."
Foreclosure and short sale
If you began falling behind on your mortgage payments, you may have sold your home through a short sale, a type of home sale in which your lender allows you to sell your residence for less than what you owe on your mortgage loan. Having such a sale on your credit report marks you as a high credit risk, and a far less attractive borrower to lenders.
Losing a home to foreclosure or selling a home through a short sale is a serious blow to your credit, and will send most consumers' scores falling by more than 100 points. Even worse, both a foreclosure and short sale remain on your credit report for seven years.
Chapter 13 bankruptcy
Bankruptcy filings stay on your credit report for a long time, too. If you file for Chapter 13 bankruptcy protection, in which a judge creates a payment schedule that allows you to pay back at least a portion of your debts, your bankruptcy filing will stay on your credit report for seven years before falling off.
Chapter 7 bankruptcy
If you file for Chapter 7 bankruptcy protection instead, this filing will remain on your credit report for 10 years. Under this form of bankruptcy you'll have to sell most of your assets to pay back what you can. The debt that you still can't afford to pay back is erased.
How to Rebuild Your Credit Score After Financial Disasters
But this doesn't mean that you won't be able to qualify for a loan or credit card for a full seven years. The more years that pile up between you and your foreclosure, the less impact a foreclosure has on your three-digit credit score. In year six, your foreclosure will remain on your credit report, but it won't exert the same downward pull on your score.
Make on-time bill payments
After a foreclosure or similar credit-busting incident, avoid being late on bills, eliminate as much of your credit card debt as possible and keep the balances low on your credit cards. If you practice these sound habits, your score will slowly -- but steadily -- rise after a foreclosure.
"Pay all your bills on time. That is the most important thing you can do," says Patrick Simasko of Simasko Law Offices in Mt. Clemens, Michigan. "Don't throw in the towel. Don't think the hole is too deep to dig out of. You can dig out of it. You just have to be fiscally responsible from that point on."
Wait until you can apply for another mortgage loan
Even if you rebuild your credit score and grow your savings account for a down payment, though, you will have to be patient if you want to qualify for a mortgage.
Applying for a mortgage after foreclosure
You'll have to wait at least seven years after a foreclosure before applying for a conventional loan backed by Fannie Mae and Freddie Mac. But you can qualify for a mortgage backed by the U.S. Federal Housing Administration, better known as an FHA loan, as soon as one year after a foreclosure if you can prove that you fell behind on your mortgage payments because of an economic event outside of your control, such as a job loss. If you can't prove this, you can still apply for an FHA-insured mortgage just three years after a foreclosure.
Getting a mortgage after bankruptcy
If you want to apply for a mortgage loan after bankruptcy, you'll also need to wait. If you want to apply for a conventional mortgage backed by Fannie Mae or Freddie Mac, you'll need to wait at least four years if you filed for Chapter 7 bankruptcy and two if you filed under Chapter 13. For an FHA loan, you'll need to wait two years after Chapter 7 bankruptcy. You can qualify for an FHA loan after you have made at least 12 months of on-time Chapter 13 payments.
Lower credit card debt
If you want to apply for a new credit card or auto loan, you won't have to wait as long as for a home mortgage. You'll simply have to build up your credit score over time by never making another late payment and reducing your credit card debt. Depending upon how low your score fell, you might have to practice these good financial habits for a year or more before you start to see any improvement in your score.
Just as with foreclosure, the negative impact of bankruptcy filings lessens over time. Again, you'll need to pay your bills on time and keep your credit card debt low to see your credit score slowly rise as the years pile up after your filing.
Show you can handle new credit responsibly
You want to reduce your current credit card debt to a manageable level, but what if you want to apply for a credit card? This is probably a good idea, if you can handle this new credit. Once you get a credit card, you can begin making charges each month. Pay off your full balance each month on time. If you do this for a long enough period of time, your credit score will steadily rise.
Look into a secured credit card
Don't expect to qualify for a premium credit card with a low interest rate when a bankruptcy filing is still on your credit report. Instead, Simasko recommends that you apply for a secured credit card. To do this, you'll need to make a cash deposit in an account tied to the card. Your credit limit is set based on the amount of your money in that account. This provides protection for the financial institution giving you a card. If you don't make your payments, the bank behind your card can simply take the money out of your security account.
Banks do, though, report payments on secured credit cards to the three national credit bureaus of Experian, TransUnion and Equifax. Make these payments on time each month and you'll improve your credit score.
Diversify credit types and prove you're a low risk
Another way to raise your financial standing is to diversify the types of credit you have on your credit report, such as an auto loan. You can still qualify for an auto loan as long as you show that you can afford the monthly payments. Prove your ability to pay with copies of your most recent paycheck stubs, bank-account statements and W-2 forms. But do expect to pay higher interest rates. Charging these higher rates provides some protection to lenders who are taking on more risk by loaning you money.
"You are going to have to wait for a while after one of these financial issues to apply for new credit or debt," Copley says. "But just because you filed for bankruptcy doesn't mean that you can never become a fiscally responsible consumer. You can. You just have to make it a habit to pay your bills on time. Do that long enough, and banks and lenders will work with you again."
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