People who file for bankruptcy aren’t always the irresponsible types who should never get a loan again. Many of the 800,000 Americans who file for bankruptcy every year are well-intentioned folks, who have fallen into crushing financial circumstances. Maybe a spouse’s sole-income producer suddenly died with insufficient savings or someone put all they owned into sustaining a business that was ruined by economic times. For some cash-strapped individuals, bankruptcy might be the only way to handle debt and get a second chance.
Despite the challenges that result from bankruptcy, people who take the right steps can go on to buy a home – whether it’s their first time or not. Being knowledgeable about what lenders expect after bankruptcy is necessary to better navigate the mortgage process. Certainly one has to build a new track record of healthier financial credit. Also, specific requirements need to be met to apply for a mortgage.
Chapters 7 and 13 Bankruptcy
In general, people who file Chapter 7 must liquidate their assets and do not have to repay debt. People who file Chapter 13 usually have a steady source of income and do not need to liquidate assets, but they do need to repay all or some debt on a specified payment plan. Both types of bankruptcies cause a severe hit to one’s credit. Chapter 7 bankruptcy stays on one’s credit record ten years and seven years for Chapter 13. Chapter 7 bankruptcy is discharged in 4 to 6 months, while Chapter 13 usually takes 3 to 5 years until debt is repaid. Then there are minimum waiting periods after discharge until one can apply for a mortgage.
Waiting Periods to Apply for a Mortgage Loan
It takes time to build credit after the discharge of bankruptcy. Lenders want to ensure that the debtor has recovered fully before extending major credit for a home. The four typical loans used for mortgages each require minimum waiting periods before someone can apply for one. They’re listed below by loan type.
FHA: Minimum 2 year waiting period after discharge of Chapter 7; no waiting after discharge of Chapter 13.
VA: 2 years after discharge of Chapter 7; no waiting after discharge of Chapter 13.
USDA: 3 years after discharge of Chapter 7; 1 year after discharge of Chapter 13.
Conventional (Fannie Mae or Freddie Mac): 4 years after discharge of Chapter 7; 2 years after discharge of Chapter 13.
Because Chapter 13 filers are looked upon more favorably (for paying back debt), they can sometimes apply for a mortgage even during the repayment process rather than after discharge, with the exception of conventional loans. In this case, there are other requirements that come into play as well, such as written permission from the court or bankruptcy attorney.
A second chance for starting with a clean financial slate means reestablishing healthy credit. That doesn’t mean opening multiple accounts. Just a couple of lines of revolving credit is sufficient and bills must be paid on time to help a credit score. Mortgage lenders will expect zero delinquencies from applicants who once filed for bankruptcy. Avoiding new debts after bankruptcy, such as car loans or personal loans, is also recommended to improve chances of qualifying for a mortgage.
It’s important to note that people who filed bankruptcy due to extenuating circumstances such as a disability, death of a provider, or other events beyond one’s control, may have a better chance at qualifying as long as good credit has been reestablished.
Obviously applicants still need to meet other qualifying factors that any borrower faces during a mortgage application, such as a credit score minimum, steady income and employment, and specific debt-to-income ratios. Some lenders will have more stringent requirements than others.
While bankruptcy may cause greater scrutiny and requirements to obtain a mortgage, it’s important to realize that people can and do recover from bad financial situations. Someone with bankruptcy history should be aware of their options before plunging into a home search and should be prepared to present to a lender life details and documentation such as medical bills, death certificate, or severance paperwork that were relevant to one’s case.
What is the average credit score after filing Chapter 7?
400s to mid 500s. To qualify for an FHA loan, you need 580-620 or higher.
Can I buy a house after bankruptcy with a co-signer?
Yes, having a co-signer improves one’s chances of getting a loan. However, that person will be on the hook for the entire mortgage if you cannot make payments on time. It’s also likely you’ll still need to wait the minimum 2 to 4 years after discharge to apply.
What’s the difference between Chapter 13 dismissal and discharge?
A discharge indicates that you’ve fulfilled your court-ordered repayment plan in 3 to 5 years. Lenders look on this favorably because you satisfied your debt as promised. A dismissal means that your debt wasn’t paid off in the required time and creditors are likely still waiting to be paid. A person will need to wait at least four years from the dismissal date before applying for a loan.
Are there other types of mortgages available to Chapter 13 filers?
Yes, there are alternative types of loans that are not backed by Fannie Mae or Freddie Mac. These are called Non-QM, Alt-A, or Non-Prime programs. Lenders assume a higher risk with these types of mortgages and borrowers should expect to pay higher interest rates and fees.
Does filing for bankruptcy mean I will lose the house I live in?
The answer depends greatly on the ability to make monthly payments, as well as other factors. A bankruptcy attorney can help determine what assets the court is likely to allow a filer to keep.
Real Estate Term of the Week
Bankruptcy Discharge: Refers to a permanent court order that releases a debtor from personal liability for certain types of debts. It comes at the end of a bankruptcy. After it is issued, the court absolves the debtor of the obligation to repay their debts, and creditors are not permitted to contact or pursue debtors for the outstanding debt.