Getting a Fresh Start with Bankruptcy Protection

Bankruptcy provides the most comprehensive fresh start available to debtors.  Most, if not all, debts are discharged.  Most, if not all, property remains in the possession of the debtor(s).  Most, if not all, property benefits from the protection of the bankruptcy.  Even better, bankruptcy can improve bad credit and provide a starting point to recreating your credit profile.  Finally, by eliminating debt expenses, debtors are better situated to purchase homes and cars in the future.

Bankruptcy & Credit

Bankruptcy can improve bad credit by eliminating the ongoing reporting of delinquent debt and derogatory remarks.  Instead, these trade lines should be labeled as “discharged in bankruptcy.” From this point going forward, debtors have the opportunity to re-establish their trade lines with new credit lines that reflect new positive payment histories.  While re-establishing the credit, the past credit profile, including the bankruptcy, tends to weigh on the credit score for only about two years.

At Hastings & Hastings, we provide debtors with information on how a credit score is created and we provide tips and advice on how to improve your credit score.  Perhaps the most important thing we do is dispel the myth that a bankruptcy affects your credit for 7 – 10 years.  In actuality, a bankruptcy appears to affect the credit score for two years or less, and lenders tend to disregard a bankruptcy after two years from the date of the discharge.  It is essential for debtors to distinguish between the reality that bankruptcy affects a credit score for approximately two years, versus the fact that a bankruptcy is reported for 7 to 10 years.  The mere reporting of a bankruptcy is irrelevant if it does not affect a credit score or hinder lending guidelines.

Bankruptcy & Buying a Home or Car

One of the most important uses of credit is to buy a home or car.  When buying property on credit, it is important to understand the lender’s perspective and how bankruptcy plays a beneficial role for debtors with bad credit.

When buying a car, the lender wants to see that an applicant has a high probability of repaying the debt and that the applicant can afford the vehicle.  In assessing risk of default, i.e. the probability of unsuccessful repayment, the lender looks at an applicant’s credit score coupled with their repayment history on other automobile loans.  The credit score is used primarily to determine the interest rate and the payment history is used to help determine if the applicant meets lending guidelines.  In automobile loans, the existence of a bankruptcy applies only to lending guidelines and most guidelines disregard bankruptcies.  The final component of purchasing a vehicle is determining debt-to-income ratio, which equates to can the applicant afford the monthly vehicle payments?  If an applicant has a high enough credit score, meets lending guidelines, and can afford the payment – the applicant is approved for financing.  Here, a bankruptcy may help a credit score, may fall within the guideline requirements, and may help lower an applicant’s debt-to-income ratio.

When buying a home, the same criteria apply.  But here, the lender requires substantiating documentation and has concrete guidelines.  First, when applying for a home loan, the lender will use a middle credit score to determine eligibility.  If approved, the credit score will also factor into determining the mortgage insurance premium.  Next, a lender will look for bankruptcies and foreclosures.  Under FHA guidelines, a bankruptcy discharge must be “seasoned” by two years and a foreclosure must be “seasoned” by three years.  Seasoned refers to the amount of time permissible between the loan approval date and the occurrence of the bankruptcy or foreclosure.   Finally, the lender will review debt-to-income ratios to determine if the applicant can afford the home payment.

Here, as with an automobile loan, it is important for a debtor to see how bankruptcy can improve a credit score, eliminate debt expenses, while having a minimal or non-existent role in lending guidelines.