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Bankruptcy timeline: Rebuilding credit

Bankruptcy clock © iStock

You've filed for bankruptcy. Now it's time to start rebuilding your credit.

It will be hard to get credit at the start, but it won't be impossible. The bankruptcy on your record means you will have to pay more to borrow money, since you'll probably be considered a subprime borrower. Subprime borrowers pay higher interest rates and penalties for defaults because they are considered a greater risk.

Kevin Chern, a bankruptcy attorney in Chicago, says that when a person files Chapter 7 liquidation bankruptcy, the debtor immediately and dramatically reduces his or her debt-to-income ratio.

"You also eliminate your ability to qualify for Chapter 7 for another eight years. In the eyes of a potential lender, you may actually appear to be a better risk immediately."

He says that most Chapter 13 petitioners also will see a reduction in debt-to-income ratio, but this won't occur as quickly.

"After three to five years of living on a strict budget, Chapter 13 debtors should be much more equipped to manage their money efficiently. In many cases, after 18 months of regular Chapter 13 payments, a debtor can refinance out of a Chapter 13, especially if the debtor has any equity in a home."

Don't know your credit score? You can check it for free at myBankrate.

Bankruptcy experts advise consumers to try not to borrow money too quickly. Instead, they should make timely payments every month to help re-establish their credit and get loans on more favorable terms.

Jessica Cecere, president of the Consumer Credit Counseling Service of Palm Beach County/Treasure Coast of Florida, suggests waiting until your credit score has increased.

Cecere says a "650 or above is when you can shop for a decent rate."

Another smart move: Keep an emergency reserve.

"Bankrupt consumers are in a better position to save because they've eliminated their debt and they need to plan for their financial future again," says Cecere. "I always say, save 10% of your income, and the minimum is whatever you can manage. Save pennies or change if you have no room in your budget and you are paying off debt."

Be sure to watch out for predatory-lending scams and payday loans. Predatory lenders seek credit-impaired consumers and charge them exorbitant fees for borrowing money. Payday loans let consumers postdate a check for the amount of the loan and the fees for taking out the loan. Those fees are the killer. Credit counselors say you could end up paying as much as 400% interest with a payday loan.

Restoring your credit rating

Bankrupt consumers should keep a close eye on their credit reports and credit scores. The consumers should get a copy of their reports from all of the major credit reporting institutions: Equifax, Experian and TransUnion. The reports should be examined for errors, missing and/or inaccurate information regarding current residence, employment and personal contact information.

Some experts suggest avoiding credit repair agencies.

"There are many unscrupulous agencies out there that will claim they can remove a bankruptcy or fix a credit report," says Samah Haggag, a senior marketing manager for Experian. "There is nothing a credit repair organization can do that you cannot do yourself."

So how much will a bankruptcy hurt your credit score? Fair Isaac Corp., or FICO, a company that produces one of the leading credit scores lenders use, offers two scenarios on its website that show how credit missteps (including bankruptcy) can affect scores. In these two scenarios, a bankruptcy filing can lower a credit score by as much as 240 points.

Experts say that after bankruptcy the degree of improvement in a score will vary. Credit expert Barry Paperno explains that this will depend on "what the consumer's score was prior to the bankruptcy filing, as well as to what degree the bankruptcy affected the consumer's score, how much new debt has been established and the time elapsed since the bankruptcy discharge."

A bankruptcy can remain on your credit report -- and thus impact your credit score -- for up to 10 years.

Credit cards

One way to start improving your credit is to open a secured credit card account right after you are discharged from a bankruptcy. Simply head to a bank, fill out an application and make a deposit into a secured account. The bank, in turn, provides a credit card with a credit line that's 50% to 100% of the deposit. The Federal Trade Commission says that the bank will usually pay interest on your deposit.

However, many secured cards come with an annual fee. And the annual percentage rates for secured credit cards may range from 15% to 23%, rates that are higher than most unsecured cards.

Be prepared to pay application and processing fees, and check to see whether you will get a refund if you're denied the card. Compare the total fees required before signing anything.

Also, confirm that the bank reports your credit card limit to the major credit card bureaus, offers periodic credit increases and doesn't report the card as secured.

Wells Fargo, for example, offers secured VISA credit cards with a minimum security deposit of $300 and a maximum of $10,000 to a person that's at least 18 years old and is a U.S. resident with a valid Social Security number. Your credit limit is 100% of the deposit. The company reviews unsecured accounts periodically for upgrade and if you are upgraded to an unsecured card, it will refund the security deposit.

Bankrupt consumers can use Bankrate's credit card search engine to find other providers of secured credit cards.

Purchasing a home and car

Ultimately, the time at which a bankrupt consumer can purchase a home or a car varies from lender to lender.

Chern, the bankruptcy attorney, says it's possible for a Chapter 7 debtor to finance a car the day after filing.

"A Chapter 13 debtor may be able to finance a car while the repayment plan is still in effect, although the trustee's permission is required after showing that the car is necessary to complete the debt repayment."

Most experts say that it will take 18 to 24 months before a bankrupt consumer, who has re-established good credit, can secure a mortgage loan after personal bankruptcy discharge.

Credit-impaired borrowers should prepare to pay interest rates that are 2 points to 3 points over conventional rates.

"Loan applicants should be wary of higher, predatory rates that exceed that amount," says Stephanie Singer, spokeswoman for the National Association of Realtors. "These borrowers should also look for loans that let them refinance without penalty, at a better rate, after they re-established their credit."

Singer suggests bankrupt consumers educate themselves about different mortgage programs, talk with a real estate agent to help find a lender that is right for their situations and check with the Better Business Bureau to identify whether lenders are in good standing.

Consumers can view how their credit scores impact the interest paid on a loan by using the loan savings calculator on MyFICO.com.

Loan representatives at E-Loan, an online lender, examine factors that include credit score, income and debt-to-income ratio.

"Generally, consumers who filed for bankruptcy within the past two to five years may experience an additional 50 basis points or 0.005% increase to the rate, compared to someone with the same credit score who has not filed for bankruptcy," says Pete Bonnikson, a senior vice president at E-Loan.

The Federal Housing Administration, or FHA, which insures residential mortgage loans -- especially first-time homebuyers and those with low-to-moderate income -- has specific procedures for bankrupt consumers and special considerations for those who have ended up in bankruptcy because of unfortunate circumstances that could include serious illness or death of a wage earner.

Chapter 13 filers aren't prevented from getting an FHA-insured mortgage if the lender documents that one year of the payout period under the bankruptcy has passed, payments have been made on time and the debtor has received the court's permission.

Debtors with a Chapter 7 bankruptcy discharge can get an FHA-insured mortgage after two years if they've shown a good payment history. However, the FHA will allow a borrower to obtain the mortgage after one year if they can show they are responsible with their financial affairs, the bankruptcy was caused by circumstances beyond their control and that the circumstances are not likely to occur again.

Bankrupt consumers whose homes were foreclosed on or who surrendered a deed in lieu of foreclosure within the previous three years won't be able to get a new FHA-insured mortgage. The lender might be able to make an exception if the foreclosure resulted from circumstances beyond the control of the borrower and the person has re-established good credit since the foreclosure.

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