Bankruptcy blues

I had a conversation with a client the other day that really bothered me. The client started the conversation by informing me that they had been through a bankruptcy seven years ago but their credit had been squeaky clean since, and now they are ready to try and get back into homeownership.

At first I winced at the thought they had waited for seven long years before re-applying for a mortgage when they could have easily qualified for one much sooner, but that wasn't the worst of it. I then asked if they had re-established any credit over the past seven years, then braced for the answer I was afraid of. They both looked at each other and then back at me with that all too familiar 'I'm not quite sure what you mean' look.

Patience not always a virtue

As I feared, they had been told at the time of bankruptcy that they would not be able to qualify for any credit for at least seven years. Now, they might not have been actually told this, but that is certainly the impression that had been made.

So here's the worst part - I then had to explain to this nice couple that although it is quite admirable that they have had perfect credit for the past seven years, they also have not re-established any credit in that time and from a lender's perspective that is the single most important component of deciding to lend again to anyone who has a previous history of bruised credit.

In fact, most lenders will want to see that you have re-established two to three 'trade-lines' or sources of credit over the past two years and that you have paid them diligently. This proves to a lender that your bankruptcy was an isolated incident and you now have the ability to manage your debt. The fact that you have spent seven years avoiding debt unfortunately does not help a lender determine whether or not you have learned how to handle or manage a debt load.

As counter-intuitive as it may seem, no debt or no active trade lines is equal to bad debt in a lender's eyes, because the best indication of future behaviour for a lender is a client's past behaviour. So what did this mean for our unfortunate couple?

After waiting patiently (based on poor advice) doing absolutely nothing for seven years to wait to apply for a mortgage, they now have to spend an additional two years re-establishing credit by securing two or three trade lines (such as a Visa or line of credit or a car loan) before any prime lenders would look at a mortgage application.

That's nine years in total! I didn't have the heart to tell them that if they had received the right advice from the beginning and simply gone out and established two or three trade lines from the beginning - which they could easily have done within a month of being discharged - they would have been able to apply for a mortgage at fully discounted rates five years ago!. I'm writing this article because I have seen too many variations of the above scenario too many times, and I feel compelled to get the word out.

Too many consumers who have experienced debt issues are not given this simple advice. So here it is in a nutshell: please spread the word so that others can be spared the same experience.

A game plan
  • If you have declared bankruptcy or applied for consumer debt proposal (OPD) and you want to qualify for a mortgage in the future here are the rules: Yes it is true that the bankruptcy or bad debt will remain on your credit bureau for seven years, but this is not to be misconstrued to mean that you will not qualify for credit for seven years.
  • From the moment you are discharged, you may apply for a variety of credit sources that will allow you to re-establish your debt and credit rating.

These include:
  • A pre-paid or secure Visa card (Put $5,000 in a trust account as security and then get a secured Visa card with a $5000 balance)
  • Have a family member or friend act as a co-signor or guarantor for you to get a secured loan from a lender as long as you are the primary borrower.
  • Get a car loan
  • An RSP loan

Your loans must report to one or both of the credit bureaus and the limits must be at least $2500. Once you get two or three sources of credit - use them and pay them off.

The purpose of these loans and credit cards are to prove to a future lender that you now have the ability to use credit responsibly. That means that credit lines must be revolving - not just static. Use them - pay them!

If you have two to three revolving trade lines and can show that you have had them for at least two years in good standing, and proven that you have re-established your credit - then you may apply for a fully discounted mortgage at virtually any lender and even qualify for high ratio mortgage insurance through CMHC.

So, with the right advice, anyone who has gone through the process of a bankruptcy can qualify for a new mortgage within two to three years. The same person, with the wrong advice, may need to wait as long as nine years for the same result. What's the cost of bad advice? Lost years of investing.

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