Most of the loans for people with bankruptcies on their credit reports typically fall into a standard description; most likely the borrower was self-employed, had good credit, something bad happened, then the bankruptcy. Rarely do I see a bankruptcy on a credit report that reflected a general disregard for the credit system altogether. That means a steady history of bad pays, judgments and collection items. No, most bankruptcies are isolated events. There was good credit leading up to the bankruptcy (that's how the borrower got credit in the first place) and good credit after the bankruptcy.

It used to be thought, and for some it unfortunately still is, that someone with a Chapter 7 bankruptcy on their credit report would nix their ability to get a home loan. Many years ago, that would have held true, but of course today most FHA loans ask for a minimum of just two years to have passed since the discharge and conventional product asks mostly for four years to have gone by. As do most other loan types. Let some time pass between the discharge and the home loan application all the while re-establishing credit, one account at a time. If the borrower with an old bankruptcy does establish good credit over a 24-36 month period then that person can expect to find the best rates available. But one little slip-up during that re-building period can be a killer.

I had a client that refinanced her home last summer. She had a bankruptcy, but it had long since been discharged in 1999 and she had re-established her credit by opening up some trade lines and paying her bills on time. Every time. Even though her credit report showed a bankruptcy discharge just a few years ago, she got the best interest rate I had to offer. No big deal there. Last week, she called me up and found a new home to buy, and could I get her a pre-approval letter to accompany her offer.

I re-entered all of her old data from her previous file, entered in the new sales price and down payment and submitted the loan electronically for an approval. After a couple of minutes had passed, I got my answer: no approval. That puzzled me because just a few months earlier she got an approval almost instantly. Something must have changed.

I pulled her credit report and scanned her trade lines. No late mortgage payments or car payments and all of her credit cards were showing as having being paid on time. Then I found the problem: a collection account that appeared just this month. No, not a huge collection, the amount was just under 90 bucks, but a collection account nonetheless. Wham! Her credit scores were instantly socked by over 90 points compared with her loan last summer.

Here's the real kicker about bankruptcies and credit scores: a bankruptcy by itself, while damaging, is not life threatening. One can always re-establish good credit in a relatively short period of time. But combine a bankruptcy with any subsequent negative item whatsoever and the result is seriously damaged scores. If it were just the bankruptcy or just the collection account, the scores wouldn't have been damaged but would have continued to slowly improve. In fact, people get great rates with unpaid collection accounts appearing on their credit report every day. The sad part about this story is that the client knew about the collection account but refused to pay it on moral grounds. She thought her doctor was “double dipping” her and her insurance company so she refused to pay the doctor twice. However it turned out, that $87 collection account turned her away from a conventional loan and instead she had to take a slightly higher rate in the form of a sub-prime loan.

Know this: if you've had a bankruptcy it's all the more important to keep a clean credit profile. Any slip-ups can wipe out your ability to obtain the best rates in a matter of seconds. If there is a dispute about a credit account, deal with it directly and don't ignore it. If not, it's your score that's hurt.