Reader Question: Improving Credit and Refinancing a Mortgage After Bankruptcy

Here’s a reader question we recently received from someone who is concerned about refinancing his mortgage and rebuilding credit after bankruptcy:

I know there is not definitive answer to this question because so many variables go into compiling credit scores. But, when I became disabled, I eventually had to file for Chapter 7 Bankruptcy. It will have been three years on January 29, 2011 since my bankruptcy was discharged.

Considering all other variables are remaining constant, would my credit score increase at the 3 year anniversary date of filing? If not, what about the 3 year anniversary date from the date of discharge?

Does the impact of the bankruptcy decrease with time or does one have to wait the full ten years until it is no longer reported?

One reason for asking is that I have a mortgage that I’m considering refinancing. I have been able to qualify for an FHA mortgage since the bankruptcy was two years old. But, I’ve been told that I would not qualify for a conventional mortgage refinance until the bankruptcy was three years old.

If you could provide me some insight in this, I’d appreciated it.

Thank you.

There is nothing particularly magical about the three-year mark as far as your credit scores are concerned. However, with FICO credit scoring models, more emphasis is placed on the most recent 24 months of data. So if the most recent 24 months of data are strong – i.e., active accounts are being reported as paid as agreed, your balances are low, etc. – then it’s not uncommon to see a significant improvement in your credit scores.

The key is to make sure you have current, positive references on your credit reports. If you avoid credit altogether, you won’t truly rebuild your credit. If you have credit accounts that survived your bankruptcy and are being paid on time, they do help. If you don’t have any credit cards that stayed open during your bankruptcy, then it would be a good idea for you to get a secured card as soon as possible. You can use it to buy everyday items like groceries or gasoline, and pay it off in full each month to avoid interest. Choose a secured card that reports to all three major credit reporting agencies. (Note: Prepaid cards do not report so don’t confuse the two.) The key is jumping right back in after a major mishap and not waiting for it to fix itself, which it won’t do.

As for your question about getting a mortgage after bankruptcy, I checked with my colleague Randy Johnson, a loan officer and author of How to Find a Home and Get a Mortgage on the Internet.

He told me that in the case of a Chapter 7 or Chapter 11 bankruptcy, generally a four-year waiting period (after the discharge or dismissal date) is required. However, exceptions can be made if there are extenuating circumstances. A two-year waiting period is allowed if extenuating circumstances can be documented.

In the case of a Chapter 13 bankruptcy, there is a distinction made between Chapter 13 bankruptcies that were discharged (completed) and those that were dismissed (not completed). The waiting period required for Chapter 13 bankruptcy actions is measured as follows:

two years from the discharge date, or
four years from the dismissal date

If you haven’t already done so, we recommend you check your FICO scores – your lenders will. In addition, since you are trying to rebuild your credit, subscribing to a credit monitoring service would be a good idea.

We hope this helps! Feel free to share additional questions in the comments below.