It is a popular misconception that if you go bankrupt you will never again be able to purchase a home. The reason for this misconception is that a bankruptcy has a negative impact on your credit report, and therefore with “bad” credit you won’t be able to qualify for a mortgage. I have two responses to that assertion.
Even those with a good credit score may not qualify for the mortgage they want. The reason for this is something called credit capacity which is simply the amount of debt a person can assume and repay based on financial ability. This ability to pay is based on your existing debt payments as a percentage of your income.
Is your credit good enough now that you can qualify for a mortgage to buy the home of your dreams? If you have a lot of debt, you probably can’t get a mortgage now, so filing bankruptcy can’t make matters any worse.
In many cases declaring personal bankruptcy makes it easier in the future to qualify for a mortgage. Why? Because if excessive debt is holding you back now, and filing for bankruptcy eliminates your debt, as a debt free person you will be more likely to qualify for a mortgage.
Filing bankruptcy eliminates most of your unsecured debts, which is good, but declaring bankruptcy also puts a note on your credit report that says you went bankrupt, which is not positive. As you can see, it’s a balancing act: you want the good on your credit report (no debt after bankruptcy) to have more weight in calculating your credit score than the negative implications of going bankrupt.
Once you have filed bankruptcy to clear your debt, then you can take steps to rebuild your credit. Pay all of your monthly bills on time, start saving money, and when you have some cash saved consider getting a secured credit card or take out a small loan that you can repay quickly to re-establish your credit.
The second most important strategy to improve your credit score is time. The farther in the past your bankruptcy is, the less negative impact it will have on your credit report.
Here’s another little known fact: while Equifax reports a first time bankruptcy on your credit report for six years after discharge, most mortgage lenders want you to be “clear” of your bankruptcy for only two years before they will consider lending to you on favourable terms. So, if you can takes steps to rebuild your credit and save for a down payment during the first two years after you are discharged, there is a high likelihood that you will be able to qualify for a mortgage.
Yes, you can go bankrupt and purchase a home, but whether or not you can qualify for a mortgage, and how quickly it will happen, will depend on your efforts to rebuild your credit and save for a down payment.