mortgage

Getting a mortgage after a bankruptcy

Justin Harelikq_v2.gifDear Bankruptcy Adviser,
So I might go bankrupt. I hear you have to wait to buy a house. Are you not allowed to purchase? If I put a certain dollar figure down payment will the bank help, even with recent filing?
-- Chris

a_v2.gifDear Chris,
I can read your letter two ways.

If you're thinking about declaring bankruptcy, but you have enough money for a down payment now or can lay your hands on it now, then I have a stern caution for you.

If you're thinking about declaring bankruptcy because you're flat broke, and you're looking for a ray of hope, then I have good news.

First, the stern warning. If you have the money for a down payment on a house then you should consider settling with your creditors. Ideally, you should pay all the debt back in full, but a settlement that clears your record now would be far better than a bankruptcy that erases your debt later.

Life after paying off debt is the same situation, more or less, as life after bankruptcy. You can clean up your credit report and still qualify for a home mortgage at reasonable rates.

Here are a couple of other issues you need to consider:

  • Someone else is giving you the money for the down payment. If you file the bankruptcy you will need to disclose to the trustee that you might be receiving a significant cash gift. In this case, bankruptcy might not be an option at all.
  • You live in a state, such as California, where home equity is protected differently than liquid assets, such as cash or stocks. If this is the case, many people buy a house now with the money that they have and file bankruptcy shortly thereafter. Do not explore this option yourself. Talk to an attorney to find out the laws in your state and disclose everything about your situation. It is important that you do not violate the law when attempting this type of transaction.

The strong likelihood, Chris, is that if you are in need of bankruptcy relief, and you have cash on hand, you will end up using that cash to pay creditors. However, I can imagine you thinking, "Hey, why not just use my cash to buy the house, use my credit cards to live, and wait a while, file bankruptcy (either Chapter 7 or 13), protect the house, and wipe away my credit card debt?"

People try to take advantage of the system in this way all the time, and sometimes it works. However, under the law that went into effect in October 2005, creditors can make stronger challenges to your bankruptcy. Plus, it's not that hard to connect the dots. The trustee (and creditors) would see that you just bought a house, yet want to get rid of all your debt. They would see how you used your credit cards in the year prior. If there are sizable cash advances, purchases at home repair or home appliance stores, or a general pattern of running up debt, the trustee assigned to your case might consider your conduct "abusive." As a result, you might not be able to discharge some of the recent credit card activity and could be forced to "reaffirm." This means, you go bankrupt, but once your bankruptcy is over you still have debt. Reaffirmation can force you to pay back a substantial portion of your debt and, in effect, vitiate your bankruptcy.

You don't want to be asking me a question in two years about how to sell your house in a hurry, Chris. This is a good time to gather more information about how best to play within the rules.

Finally, here's that ray of hope I promised:

If, a year or two after you declare bankruptcy, you can get your financial act together, pay your bills on time and manage to put together a nice big down payment, you can get a decent mortgage. There are a lot of variables to it, and all lenders have their own rules, but these days, you don't get shut out of the mortgage market entirely after bankruptcy, and having a big chunk of change can whittle down your rate. The more time there is between you and the bankruptcy, and the bigger the bankroll you bring to the table, the closer to "normal" rates you'll get.

Justin Harelik is a practicing bankruptcy lawyer of counsel to Price Law Group in Los Angeles. To ask a question of the Bankruptcy Adviser go to the "Ask the Experts" page, and select "bankruptcy" as the topic.

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