A bankruptcy is generally the result of something very bad happening in someone’s financial life. No one enters into a loan agreement of any sort, either the debtor or the creditor, with the intent to default on the loan. Instead, a loan is issued in good faith and the creditor expects to be paid back based upon the terms of the note. The borrowers get to use those funds to make a purchase without having to come up with the necessary cash all at once and in return pay the lender back the loan amount over time with interest. It’s a win-win. But when a disruptive event suddenly shows up at a borrower’s door, things can begin to crumble.
The mobile phone starts to ring from creditors wanting to know where their money is. Late payment notices begin to stuff the mailbox. Emails are received demanding payment. But the borrowers can’t pay because of something that happened. Primarily it’s the loss of a job due to an employer closing down and no new work can be found. An extended illness of a family member is also a common culprit or worse a death in the family. Or, it can simply be a matter of consumers taking on too much credit and applying for every credit card that comes in the mail. At some point, the consumers begin to fall behind, letting some accounts go unpaid wile concentrating on others. When it appears there is nowhere to turn, a bankruptcy may be the only answer.
But a bankruptcy isn’t a financial death knell. Instead, it provides the consumers with a fresh start and once they get back on their feet they can begin to reestablish their credit profiles, including planning on financing a home in the future with a new mortgage. Yes, you can get a mortgage after a bankruptcy.
There are two types of personal bankruptcy filings- a Chapter 7 and a Chapter 13. A chapter 7 wipes out all dischargeable debt. A chapter 13, sometimes referred to as a “wage earners” plan is a court-ordered and trustee-monitored repayment schedule which allows the borrowers to repay an agreed upon amount over time. Let’s take a look at how lenders view both.
Chapter 7: Conventional
The most common mortgage programs today are those underwritten to standards issued by Fannie Mae and Freddie Mac, often referred to as “conventional” loans. There is a waiting period that must occur before a consumer is eligible to apply for a mortgage of four years since the date of the discharge. It’s important to note these waiting periods apply to the date the bankruptcy was discharged, not the date originally filed. The discharge date is a public record.
During this four year period, consumers are expected to reestablish credit and have a spotless payment history. Some may wonder how anyone can get a credit card or an automobile loan after a fresh bankruptcy filing or discharge but there are credit companies that do specialize in helping people get back on their feet credit-wise. It might be a simple credit card with a $300 limit or even a secured credit card where the consumers place a deposit on hold with the credit card company before the card is issued.
A mortgage company will order a credit report and review the credit obligations listed as well as make sure there are no payments made more than 30 days past the due date.
In addition, a mortgage company will want to see timely rental payments as well. A mortgage lender can ask for copies of cancelled checks, front and back, showing how much rent you paid and when the check was written and deposited.
Government-Backed Loans
There are three primary government-backed mortgage loans, so-called because each carries an inherent guarantee to the lender compensation for part or all of the mortgage should the loan ever go into default. These three loans are the VA, FHA and USDA mortgage programs.
VA loans need a 24 month waiting period for a Chapter 7 with reestablished credit. USDA mortgages ask for a 36 month waiting period while FHA loans need 24 months, just like the VA program. However, the FHA has a special provision called a Back to Work mortgage that can provide an FHA loan in as little as 12 months since the discharge which addresses “extenuating circumstances” that led to the bankruptcy.
The Back to Work FHA loan requires you to document the “economic event” such as a short sale, foreclosure or bankruptcy that occurred due to events beyond your control. Next, you must document that you have recovered from the event and demonstrate to the lender the event will not occur in the future. Third, your income must have declined by at least 20% for a minimum of six months as a result of the economic event.
Chapter 13: Conventional
When a court approves a repayment plan to creditors using a Chapter 13 bankruptcy, the creditors receive monthly repayments overseen by a court-appointed trustee. These payments must be made on time, every time. With reestablished credit, both Fannie Mae and Freddie Mac require at least 48 months since the discharge date of the Chapter 13. The discharge date with a Chapter 13 is when the trustee has determined the consumer has properly completed the repayment schedule as directed by the court.
There are also times when a Chapter 13 is dismissed during the repayment period either by early payment of the amounts included in the bankruptcy or the court and creditors agree to dismiss the Chapter 13 altogether. In the instance of a dismissal, Fannie and Freddie both ask for a waiting period of just 24 months. Again, reestablished credit is key here.
Government-Backed Loans
VA loans require a minimum of 12 months from a Chapter 13 bankruptcy discharge or a dismissal. The lender will be required to determine the payments during the Chapter 13 were made in a timely manner. Yet it’s important to note here that 12 months is rarely enough time for a borrower to reestablish a credit history but it is what the VA requires.
FHA loans need a minimum of 12 months since the Chapter 13 while there is no waiting period when the bankruptcy is dismissed. USDA loans however require the Chapter 13 be discharged or dismissed for at least 36 months.
Additional Mortgage Loan Options
Note while conventional and government=backed mortgage programs make up the bulk of mortgage loan approvals in today’s market, there are others.
Jumbo loans for example, those above the conforming loan limits set by Fannie and Freddie Mac have their own guidelines and they can vary widely. Some jumbo lenders won’t even look at an application with a bankruptcy showing while others will but have a waiting period of anywhere from two to seven years.
Portfolio loans are those underwritten to internal lending guidelines and do not conform to third party standards such as those issued by Fannie, Freddie, VA, FHA or USDA lenders. A portfolio loan however won’t have as competitive interest rates and down payment requirements can be much higher as well.
Are You Ready?
To some, even the thought of taking on a brand new mortgage after going through such as a traumatic event as a bankruptcy isn’t on anyone’s “to do” list. Yet over time as consumers get back on their feet and realize that a bankruptcy is a necessary financial tool and designed to allow borrowers to recover from the extenuating circumstances that created such financial havoc.
Over time, borrowers will become more comfortable with credit and soon get back on their feet with a new job, a fresh start, a brighter future and at some point…a new home!
