The steps leading to bankruptcy can be devastating. Whether you were hit with big medical bills or just racked up too much credit card debt and couldn’t pay, bouncing back can be tough. One community member emailed me a question about buying a home after bankruptcy, and I have good news for her.
After acquiring some 90k in medical debt, I had to file for bankruptcy. Let’s not go into the details. Anyway, the bankruptcy is cleared and I only have my student loans to worry about. But what’s a better way to start rebuilding my credit? Car loan or small credit cards? Is it better to get a car loan at a bad interest rate, or just save up and get something in the 5-6k range?
I’ve never racked up big debt before, except for the stuff I couldn’t control, and I always pay my bills. But at the moment, I am a credit pariah!
I’d like to own my own house someday. But how?
That’s an excellent question, and far more common than many people realize. Going from bankruptcy to home ownership takes some patience, but it is very possible. You will have to follow a few main steps. First, clean up your old problems. Second, build up positive credit. Third, position yourself to buy a home.
Clear Your Current Debt
The first step to re-building your is to get rid of your old negative information on your credit report. The best way to do that is pay off any outstanding debt, starting with high-interest rates first and working your way down, until you are debt free.
When you close a credit account or make a final payoff on a negative item it will take seven or ten years to drop off of your credit report from the day your final payment is reported to the credit agency. That is a long time, so get things paid off as quickly as possible.
Even if you have been good with a credit card for a few years in a row, any negative information like late payments or missed payments will stay on your credit report for the life of the card plus seven years, so get those paid off and closed as soon as possible. If an account has no negative information associated with it, make sure to keep it open as that is a great start to building positive credit.
You can get a free copy of your credit report from each of the three big reporting agencies every year by law. I get one every four months and have a reminder on my calendar so I don’t forget. You can setup your calendar reminders like this: January 1st: Experian, May 1st: Equifax, September 1st: TransUnion.
Build a Positive Credit History
Now that your negative information is on its way out, time to build positive information on your credit report. The best way to do that is to get a credit card or two with no annual fees. Pay them 100% in full each month to ensure you don’t pay any interest.
With a little help from Google, you should be able to find a low-limit card for people who have gone through bankruptcy. If not, look for a bank that will offer a secured credit card. With a secured card, you put cash in a bank account that has to just sit there as collateral for the bank as long as you have your account. This is totally worthwhile to help you start building up your credit score as soon as possible.
Building a positive history of on-time payments shows banks you are responsible with your credit and helps build a strong credit score. There is no quick-fix for credit problems, but that doesn’t mean there is no fix at all.
Remember that negative credit items got you into trouble the first time, so you want to show positive credit history. Never miss a payment or make a late payment. The easiest way to make sure everything works is to schedule an automatic payment for your minimum payment in case you forget to pay.
You don’t have to use the card every month. Just use it for something small a few times a year to build up the positive history and keep your account as active in the bank systems.
Car loans are another way to build good credit by making regular payments with an installment loan, but your student loans will already show that type of credit history, so no need to get extra debt at a high interest rate just for the sake of fixing up your credit report.
Wait For Your Bankruptcy to Drop from Your Credit Report
A chapter 13 bankruptcy will stay on your credit report for seven years and a chapter 7 bankruptcy will be there for ten years. There is nothing you can do to speed that up, and most banks will not lend to someone with a bankruptcy on record, but it is not completely unheard of.
The timer starts when your bankruptcy is listed as discharged, or completed, not from the day the bankruptcy is filed.
This takes a lot of patience, but by the time the bankruptcy drops you should have seven to ten years of positive credit history from your newer cards and all of the other bad stuff will be gone too. That is a 100% clean slate.
Build Up a Strong Down Payment
While you’re waiting for your credit report to build, start saving for a down payment. To avoid private mortgage insurance, you’ll need a 20% down payment. On a $200,000 home, that’s $40,000 in cash. Saving forty grand takes a few years, so don’t delay.
You can save with an automated savings plan if you have regular income or just make transfers when you get a chance. I suggest Capital One 360 for savings as they have competitive rates and no fees or minimum balance.
Today Is Day One
Remember that this entire process can take years. Unless you can save up enough to buy a home with cash, getting your credit in order will take time and should be priority number one. Don’t wait a single day longer to start building positive credit so you can buy when the timing is right.
Do you have any tips for our friend and community member? Please share what you would do in the comments. Remember to keep it constructive and positive. Negative comments about her past will be promptly removed.
Image from miamism / flickr