One of the most rewarding things I do as a Mortgage Consultant is help people who’ve had major financial difficulties in the past get a fresh start and buy a new home. In my career I’ve seen hundreds of mortgage applications from people who have filed bankruptcy and/or lost a home in foreclosure. Many of these people were given a second chance too early with subprime lending. For example, until 2007, it was possible for someone with a recently discharged bankruptcy to qualify immediately to buy a home with no money down. After the mortgage and banking crisis of the last few years, obviously that is no longer the case. But there is still home ownership hope for those with past credit problems.
With the economic challenges we’ve faced over the last several years, we shouldn’t be surprised that bankruptcy filings across the nation were up by 32% in 2009. And we’ve all heard about the giant waves of foreclosures and short-sales that are still rolling over the US. Millions of people need a fresh start. Odds are someone you know is one of them. Many hard-working, honest people who used to have perfect credit histories and very high credit scores are now faced with the challenge of recovering from a serious blow – not just financially, but emotionally and psychologically as well.
Before I offer some tips on how to re-build your credit history as quickly as possible, I want to suggest this mantra of encouragement to those who have fallen on hard financial and credit times:
“You are not your credit score!” (Pass it on.)
It’s funny how we use our credit scores as one more measurement of our self-worth and accomplishments. But is someone with a 780 credit score a better person than someone with a 620 score? Maybe, maybe not. Are they a better credit risk? Statistically speaking, yes. But, as the great Iron Maiden sang in one of their old and famous songs, The Prisoner: “I am not a number…I am a free man!” If you’ve had your debt slate wiped clean through bankruptcy, you are now free to improve your credit score and start re-building a solid financial life! Let’s look at the most effective way to do that:
MM Tip #1: Open a Secured Credit Card ASAP
If over-spending and over-extension of credit got you into trouble in the first place, you may have sworn you’ll never borrow money again. Or, at least, never use credit cards again. Like it or not though, our economy places a great deal of importance on credit scores. Your scores affect everything from your insurance premiums to your ability to rent an apartment or land a job. Do yourself a favor and surrender to the system on this. Be selfish. Tell yourself you’re going to do whatever it takes to build a great credit score. It will help open doors and save you a ton of money over time. Be patient and persistent. I promise it won’t take as long as you might think. Many people mistakenly assume they won’t be able to buy a house for 7 years or longer after a foreclosure or bankruptcy. Not true. It’s possible to get a home loan as soon as 2 years after a bankruptcy and 3 years after a foreclosure. Even sooner in some short-sale situations.
The first thing you should do is open a secured credit card. This type of credit card is backed by a savings account you open with the credit card company. The savings account serves as collateral to mitigate the credit risk to the company. Your own money is at stake and will be used to pay off the credit card balance should you not make payments as agreed on the card. The credit limit approved on the card is between 50% to 100% of the amount you deposit as collateral into the savings account. For example, if you deposit $500 into the savings account, you would receive a credit card with a limit of $250 to $500. Many credit card companies offer new accounts to people with a recent bankruptcy or foreclosure. You can go to www.creditcards.com and search for secured credit card offers. You should also check with your bank or credit union to see what they might offer. Keep in mind though if you had credit with them and they lost money as a result of your bankruptcy, they may not be very excited about extending credit again, even if you offer your own cash as collateral.
Be sure to read the fine print of the credit card agreements with the different offers and pick one that seems to make the most sense to you for your circumstances. Yes, the interest rates are high. But, if you use the card strictly for purchases (cash advances are a rip off) and pay off your balance in full every month you should be able to avoid paying any monthly interest. Most of these cards do have a monthly and/or annual fee. They also charge fees for several optional uses of the card. The best strategy is to use the card conservatively and responsibly. Use it to buy every day essentials like groceries and gas. Don’t use it to buy stuff you don’t need and/or can’t really afford. Pay attention to your balance and do NOT exceed your limit. In fact, it’s best if you keep your balance under 40% of your high credit limit. Your goal is to have an active credit account with a company that reports your monthly ON TIME payments to all three credit bureaus. Nothing builds credit scores faster than a clean payment history.
MM Tip #2:
Check your credit history a few months after your bankrupty or foreclosure is completed. Make sure everything is reporting accurately. Are all the accounts that were included in your bankruptcy reporting as such? Is the foreclosure reporting accurately? Ask someone who’s experienced in reading credit reports to review it with you. Take the actions necessary to make sure everything is accurate. You want your fresh start to be just that as far as your credit report goes. It’s best not to wait a couple years only to find out a bunch of old accounts are not reporting correctly.
MM Tip #3:
If you’re in the market for a car, shop around to see what dealers might be able to offer you for financing. Brace yourself because the rate will be higher than you expect! Make sure the payments are truly affordable for you. Do your homework on the price of the car and don’t overpay. Your first questions should be, “will my payment history be reported to the three credit bureaus?” If not, forget it. Credit that doesn’t show up on your report will do nothing for your scores.
MM Tip #4:
Check with your current bank or credit union for possible credit options. I’m surprised on a regular basis about how quickly some borrowers with recent negative credit are able to secure a credit card or car loan from their bank. They may say “no” but there’s only one way to find out: ask. Again, you want to be sure whatever credit you’re able to secure will result in a payment history reported to all three bureaus on a monthly basis. Note: most debit cards do NOT report a pay history since they are not an extension of credit.
MM Tip #5:
Check your progress on a quarterly or semi-annual basis. As you start to re-build your credit history, it’s important to know where you stand. Your scores WILL increase if you make your payments on time, every time, keep your credit card balances low relative to your limits and pay attention to medical bills, traffic tickets, etc. and don’t let them go to collection – ever.
MM Tip #6:
Repeat often: “I am not my credit score, but I WILL have one to brag about!”
Mike Anderson is a Mortgage and Personal Finance Consultant with nearly 20 years experience. He has a degree in Economics from Stanford University. Mike is a Utah native and currently lives in Salt Lake City.