If you’ve recently filed for bankruptcy or are considering filing for bankruptcy, a home loan may sound out of the question. The impact of bankruptcy on mortgage financing isn’t as bad as you may think. You CAN get a mortgage after declaring bankruptcy; the amount of time after depends on the type of loan you are applying for and the type of bankruptcy you file. Let’s cover the different types of bankruptcy, the bankruptcy process, reestablishing credit, and steps to take to prepare to get a mortgage.
What is Bankruptcy?
Bankruptcy is a legal proceeding initiated when someone is unable to pay debts and obligations as they occur. It can provide a reset for people who fell on hard times.
Types of Bankruptcy
For individuals, there are two main types of bankruptcy – Chapter 7 Bankruptcy and Chapter 13 Bankruptcy.
Chapter 7 allows for the discharge of unsecured debts like credit cards, medical bills, and signature loans. However, you must liquidate all qualifying assets to pay the debt. Consequently, secured loans, like houses or cars, will need to be surrendered. A Chapter 7 bankruptcy usually takes 90 days to be completely discharged.
Chapter 13 bankruptcy is for those who make too much to qualify for Chapter 7. A repayment plan is set up, usually for a 3 to 5-year period. The bankruptcy is discharged after the 3 to 5-year payback period.
Bankruptcy Process
The process typically begins with the debtor petitioning the court for bankruptcy protection, which triggers an automatic stay, halting most collection actions by creditors. Different procedures and requirements apply depending on the type of bankruptcy, whether Chapter 7 or Chapter 13. In Chapter 7, a trustee may liquidate non-exempt assets to repay creditors, whereas in Chapter 13, individuals are allowed to restructure their debts and create a repayment plan. Throughout the process, debtors must disclose their financial affairs, attend meetings with creditors and trustees, and adhere to the court’s orders. While bankruptcy can offer a fresh start for those overwhelmed by debt, it also carries long-term financial consequences and should be approached with careful consideration and guidance from legal professionals.
Waiting Periods After Bankruptcy
The amount of time you must wait to apply for a mortgage after bankruptcy will depend on the type of loan you wish to get and the type of bankruptcy that was filed. You can learn a little more about the credit score and loan requirement differences between FHA and Conventional loans here.
If you file for Chapter 7 Bankruptcy and later want to obtain an FHA loan, there will be a two-year waiting period after discharge, assuming a good credit score and re-established credit. For USDA loans, the waiting time is three years. For Conventional loans, the waiting period is four years.
While there are rules that allow borrowing inside Chapter 13, it is extremely hard to qualify for and is very rare. You can qualify for a FHA, VA, or USDA mortgage after the discharge of Chapter 13 after one year. For a Conventional mortgage, the wait is two years.
In both types of bankruptcy, you will have paperwork. For mortgage purposes, make sure to keep the initial filing and notice of discharge for later use, as you will need these when applying for a mortgage.
Rebuilding Credit
Many factors go into a credit score, but the main ones to focus on after bankruptcy will be making your payments on time, staying within your credit limits, and keeping your debt amount low. There are a few ways to help improve your credit score over time.
Assuming good income, the minimum credit score needed for a mortgage as of the date of this blog is 600. The best place to start is to eliminate some accounts through bankruptcy, but keeping a credit card with a small balance will help re-establish a credit score.
You can obtain a secured credit card if you don’t have any credit or need to work to raise your credit. Capital One and Discover both have secured credit card programs. A secured credit card allows a borrower to place funds on deposit for the line of credit.
For example, John gets a secured credit card. John mails off $1,000 to Capital One. In exchange, Capital One grants John a credit card with a $1,000 credit limit. This deposit acts as security for the issuer in case the cardholder defaults on payments. The cardholder can then use the secured card for purchases, just like a regular credit card. Timely payments on the secured card help establish or improve the cardholder’s credit score. If you make on-time payments, they might eventually refund your deposit to make your credit card unsecured (and maybe even raise your credit limit). Overall, secured credit cards serve as a stepping stone for individuals seeking to establish or repair their credit history.
Getting a mortgage
Once your bankruptcy is discharged, it’s time to find a lender. For example, John just completed a Chapter 7 Bankruptcy. He still has a good job and wants to buy a home in two years.
John will look for a trustworthy lender to get pre-approved after one year. However, he won’t be able to apply for a mortgage until 12 months later if he’s applying for an FHA loan. While some bankruptcies are clean, and the credit report shows all applicable accounts as discharged in bankruptcy, some are not. In those cases, a credit cleanup may be required. This is the reason to get pre-approved so far in advance, as an experienced lender can help assist you in that process.
Set a goal of having three accounts report on your credit for 12 months after a bankruptcy is resolved. If you’re renting, be sure to pay your rent in check. This will help support on-time trackable payments for the roof over your head. It’s best to be upfront with your lender and ensure you are working through and sticking to any plans established to keep you on the path to being approved for a mortgage.
To Conclude
Needing to declare bankruptcy is not a financial death sentence. You can still get a mortgage and buy a home after bankruptcy. It’s best to know your options when it comes to getting a mortgage after bankruptcy so you are prepared for the time you will need to wait and the requirements you will have to meet to secure a mortgage. Having a plan in place for after discharge will help you be fully prepared and well on your way to homeownership after bankruptcy.