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Recovering your financial standing after bankruptcy can feel like an uphill battle, but it could be easier than you think. Take it one step at a time, and you can do it. And if you are looking for a home equity loan, there still may be good options for you to get the money you need.
Home Equity Loan versus HELOC
Before filling out any loan applications or even talking with lenders, it’s important to know the difference between a home equity loan and a home equity line of credit, or HELOC. Although both rely on your existing home equity for collateral, they do not operate in the same manner.
With a home equity loan, you receive the full value of the loan upfront, which you will repay over a set period of time with a fixed interest rate. How much you can borrow is limited to 85% of the home’s equity. As with all loans, how much you qualify to borrow is based on several factors, including your income, credit history and your home’s market value.
Home equity loans also include many fees, such as application or loan-processing fees, appraisal fees, origination fees, document preparation fees and recording fees, among others.
HELOCs operate much like a credit card; as a revolving line of credit, you will be given a maximum amount you can borrow (the credit limit). However, unlike a home equity loan, you don’t have to take all of the money upfront. Instead, you can withdraw as much money as you need when you need it, usually by writing a check or using a debit card connected to the account.
You will be charged interest only on the amount you borrow (the balance due), and you will make payments only on the amount borrowed rather than the total amount available (credit limit).
While HELOCs vary in nature by lender, you may be able to borrow up to 85% of your home equity. Unlike a home equity loan that provides the homeowner with the full loan amount upfront and must be repaid within a specific timeframe, a HELOC may operate with a more fluid schedule. You may be able to withdraw funds at any time for a certain time period, making payments on that balance along the way, or your draw period may be open for a fixed time, at which point you’ll be required to repay the outstanding balance.
HELOCs also incur a variety of fees at the onset, including application fees, appraisal fees, a title-search fee and so on. HELOCs may also have ongoing fees like a transaction fee each time you withdraw funds.
Remember that with either loan option, your home is the collateral you offer to ensure that you will repay the loan. If you fail to pay as agreed, you could be forced to surrender your home to pay off the debt.
What loans are available if you have filed for bankruptcy?
Before looking at available loans following bankruptcy, it’s important to note the difference in types of bankruptcy filings as they affect your loan options. With a Chapter 7 bankruptcy, you liquidate your assets and use the proceeds to repay your debts. Some exemptions permit you to keep specific personal property. Once the bankruptcy is processed, your debts may be “discharged,” or written off, which means you are no longer required to pay them.
Under a Chapter 13 bankruptcy, you agree to set up a plan to repay all or part of your debts. Although a Chapter 11 bankruptcy may be an option, this category of bankruptcy is typically used to reorganize a business, making it a better choice for small-business owners rather than individuals. It is used for businesses that want to keep their companies active and pay their debts over time.
When applying for a home equity loan or HELOC, you won’t be able to do so right away. In some cases, you might be able to qualify for one of these loans three years after your bankruptcy is discharged, but, in general, it’s more common to wait for five to six years to receive loan approval.
If you are looking for a Federal Housing Administration, or FHA, loan, you’ll have to wait for a minimum of two years per the FHA Guidelines if you filed a Chapter 7 bankruptcy. For those who filed a Chapter 13 bankruptcy, you will need a verified record of your repayments for at least one year, as well as the court trustee’s written approval for the loan.
Tips on repairing credit after bankruptcy
As you consider applying for a home equity loan, the best step you can take right now is to repair your credit standing. A bankruptcy can stay on your credit report for up to 10 years, but it doesn’t have to overshadow your creditworthiness as a valued borrower. There are simple tips you can follow to help you rebuild your financial foundation, making you a good risk for lenders.
Pay on time: The best day-to-day effort you can take to rebuild your credit is to pay all your bills on time. Avoiding late or missed payments goes a long way toward boosting your credit score and showing your commitment to paying your debts.
Create and follow a budget: Setting up and adhering to a budget will help you manage your money better, which can help prevent the need to take on additional debt.
Apply for a secured credit card: Similar to a prepaid credit card, a secured credit card operates based on money you pay upfront, then draw upon as needed. Using this card and “repaying “ the amount used each month can help establish a good credit history on your report.
Apply for an unsecured credit card: After your bankruptcy is discharged, you may start to receive offers for unsecured credit cards — traditional credit cards that don’t require a deposit. Using one of these cards could be beneficial, if properly managed. First, if you use the card for a small purchase each month — for instance, a tank of gas — and pay that balance off every month, you’ll build up a good history of regular payments. Second, it can improve your credit utilization ratio; this ratio looks at how much available credit you have versus how much credit you use each month. If you have $1,000 in available credit and use $100 of that credit each month, your credit utilization ratio is 10%, which is below the preferred maximum ratio of 30%.
Have someone cosign on a card or loan: You can draw upon a family member or loved one’s good credit by having them sign onto a credit card or loan with you. Their good credit history can help you get the card or loan, but your credit will receive a boost when you pay the card or loan as agreed each month. There is a drawback, though, if you fail to pay the debt as they will be responsible for covering the payments for you.
Keep in mind that you will need to make changes in how you approach financing and managing debt in order to stay out of the trouble that led to bankruptcy. As such, it’s imperative for you to consider all of your options to see if a home equity loan or HELOC is the right option — or even necessary — for you.
It’s especially important to note that interest rates are on the rise, which could make home equity loans or HELOCs more expensive. Also, with the changes under the federal Tax Cuts and Jobs Act (TCJA), enacted in December 2017, the tax benefits of a home equity loan or HELOC may no longer be available or beneficial for you. Evaluate the additional factors before deciding to apply for these loans.