As the cost of living rises and wages stagnate, many Americans struggling to balance financial obligations. Household debt levels have been on the rise for the past few decades, as younger generations try to balance paying off student loans, saving for retirement, and buying a home in a difficult housing market.
Bankruptcy rates have risen over the past decade, driven by more households battling unmanageable debt and the threat of housing foreclosure.
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Most consumers seeking debt relief file for Chapter 7 bankruptcy (involving liquidating assets to repay creditors) and Chapter 13 bankruptcy, which reorganizes debt to be repaid within 3 to 5 years.
While bankruptcy may be the best option for those facing insurmountable debt, it may also damage your credit score and prevent you from getting a mortgage and buying a home in the future.
Dave Ramsey reveals how filing for bankruptcy can impact your financial standing in the long run.
Dave Ramsey explains how bankruptcy affects credit scores in the long run
Credit scores are one of the biggest financial indicators lenders look at when assessing mortgage applications. A credit score not only demonstrates your ability to repay debt, but also strongly influences the interest rate you'll receive on a mortgage loan.
Homebuyers with lower credit scores are deemed higher risk, and typically require a higher down payment to offset the heightened liability.
Since bankruptcy involves getting debts discharged, it signals to lenders that a person may have trouble managing their debts going forward. Though the process may make sense overall financially, Experian estimates it takes an average of 200 points off of a credit score.
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“We won’t sugarcoat it: bankruptcy is a devastating, life-altering decision that drags you through the legal mud for all to see. Beyond the emotional impact, here are some ways bankruptcy can wreck you financially,” Ramsey said.
He warns that consumers may be dealing with the fallout from bankruptcy up to a decade after filling.
“It’s important to know that a bankruptcy will affect your FICO score. Hard. And that hit lingers. In fact, Chapter 13 bankruptcies stay on your credit report for about seven years, and Chapter 7 bankruptcies stay on there for 10 years,” he continued.
Dave Ramsey warns Americans how bankruptcy affects mortgages and the homebuying process
The mortgage loan application process can be burdensome, involving employment history, proof of income, and the borrower's debts and credit score.
Filing bankruptcy significantly hurts a consumer's credit score, making it difficult for homebuyers to get approved for mortgage loans or obtain a competitive interest rate.
Ramsey explains that it will take several years for anyone who has filed for bankruptcy to financially recover and get approved for a mortgage.
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“A bankruptcy is a huge red flag for mortgage lenders. While it’s not impossible to buy a home after going through bankruptcy, it could take one to four years before anyone will even think about letting you take out a mortgage,” Ramsey continued.
While each family's financial circumstance is unique, most Americans will find buying a home is far more difficult after bankruptcy.
“How soon you can qualify again depends on the type of bankruptcy you filed and the type of mortgage.”
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