Getting a mortgage after bankruptcy: What to know

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Bankruptcy can give you a fresh financial start, but it can also hurt your credit — and that can make it difficult to get a mortgage. Here’s what is involved in getting a mortgage after bankruptcy, and how to increase your chances of qualifying for a loan.

Why it can be challenging to get a mortgage after bankruptcy 

There are two main types of bankruptcy: Chapter 7 and Chapter 13. The former is the most common type, and it involves a liquidation, meaning most or all of your outstanding debt is discharged. A Chapter 7 bankruptcy is usually approved for those with limited income to repay what they owe.

A Chapter 13 is known as a “reorganization bankruptcy.” Here, you create a plan to repay your creditors, taken from your earnings, at a percentage of what you owe them — up to 100 percent. This repayment plan takes longer than a Chapter 7, often three to five years, and it has to be approved by a bankruptcy court.

Both types of bankruptcy can negatively impact your ability to get a mortgage. That’s because a Chapter 7 or Chapter 13 stays on your credit report for 10 years or up to seven years, respectively, from the date of filing.

“A mortgage lender can see that, at one point, you had trouble managing your debts,” says Adem Selita, CEO of The Debt Relief Company in New York City. “This can be interpreted as a red flag for loan officers, who may believe that history will repeat itself.”

You’ll also be required to wait a certain length of time following a bankruptcy before being eligible again for a mortgage loan. Even after that time has elapsed, it may be more difficult to obtain a mortgage loan than it would have been if you didn’t declare bankruptcy, and you may pay a higher interest rate.

How soon after bankruptcy can I qualify for a mortgage?

The good news is you won’t be prohibited indefinitely from qualifying for a mortgage following a bankruptcy. After a minimum number of years, you can apply for a home loan and likely be approved if you meet the qualifications.

Chapter 7 bankruptcy

Leslie Tayne, attorney and founder of Tayne Law Group in Melville, New York, says you’re eligible for a mortgage a few years after a Chapter 7 discharge of debt.

“For FHA and VA mortgages, the waiting period for Chapter 7 bankruptcies is two years from the date you file the paperwork with the court, three years for USDA mortgages, and four years for a conventional mortgage,” Tayne says.

Ashley Morgan, a debt and bankruptcy attorney in Herndon, Virginia, says there are limited-availability programs that can allow a Chapter 7 debtor to qualify for FHA financing in as little as one year — “but you have to prove that your debts or financial issues were due to extreme circumstances outside your control,” Morgan says, “such as the death of a spouse or divorce.”

Chapter 13 bankruptcy

The waiting periods following a Chapter 13 bankruptcy are, thankfully, shorter.

“For FHA, VA and USDA mortgages, it’s only one year from the date the papers are filed with the court,” Tayne says. “For a conventional mortgage, on the other hand, the waiting period is two years from the discharge or four years from dismissal.”

Tayne explains that a “discharge” happens when you complete your repayment plan laid out by the court and the matter is discharged by the court. “Dismissal” occurs when you cannot complete the repayment plan and the case is, therefore, dismissed by the court — essentially meaning the bankruptcy was not successful. The waiting periods are shorter for discharges because the filer has been working toward improving their credit through the repayment process.

However, you may qualify for a mortgage during the Chapter 13 process if you can demonstrate that you’ve made 12 months’ worth of on-time payments and get court approval.

“Here, the court will often want to review the financing terms and compare your monthly mortgage payment to the rent payment list in your bankruptcy,” Morgan says. “If your new monthly mortgage payment would be higher, you usually have to show how you will afford the increased payment and why that money shouldn’t go to creditors.”

Overall, the waiting periods for Chapter 13 aren’t as long as for a Chapter 7 “because the borrower has already taken time to improve their financial situation through the Chapter 13 bankruptcy process, which involves some repayment,” Tayne says.

What type of mortgage can you get after bankruptcy?

After a bankruptcy has discharged and closed, you may be eligible for a conventional mortgage as well as an FHA, VA or USDA loan if you qualify.

“But you’ll need to meet the waiting period rule and show that you’ve worked to repair your credit,” Tayne says.

Most conventional mortgages will require a credit score of at least 620. Your credit score and the amount you’ll be able to commit to a down payment (many lenders prefer 20 percent) will affect the interest rate you are quoted.

For an FHA loan, you’ll need to demonstrate that you have improved your credit and haven’t taken on any additional debt since the bankruptcy.

Tayne says FHA loans “generally require a lower minimum credit score and down payment than conventional mortgages” (as low as 580 and 3.5 percent down, or 500 and 10 percent down). USDA loans can be had for no money down, and there are no minimum credit requirements. Eligible veterans, service members and qualified surviving spouses with a minimum credit score of 620 can apply for a VA loan for no money down.

How to apply for a mortgage after bankruptcy

The experts recommend working hard to bounce back from bankruptcy. That means improving and monitoring your credit before attempting to apply for a loan post-bankruptcy.

To apply for a mortgage after bankruptcy:

1. Check your three credit reports for free at AnnualCreditReport.com, disputing and resolving any errors you spot, and following credit-use best practices.

“Make sure all debts that should be marked as included in your bankruptcy are reporting with zero balances on your credit reports,” Morgan cautions.

Additionally, “focus on making payments on time and as fully as possible. If you’re struggling to rebuild your credit but are getting new credit applications declined, consider opening a secured credit card, which is generally easier to qualify for,” Tayne says.

2. Avoid applying for and taking on too much new debt, and refrain from closing accounts, which can also lower your credit score because it can affect the length of your credit history and credit utilization.

3. If at all possible, look to save. Remember that the larger your down payment saved, the more favorable your interest rate will be.

4. Gather and organize all your bankruptcy discharge and schedule documents, recent pay stubs, two years of tax returns and other paperwork that lenders will want to see proof of.

5. Compare lenders and loan types carefully following the minimum bankruptcy waiting periods. Tayne says some lenders, often smaller ones, are more willing to work with borrowers who went through a bankruptcy, so it pays to shop around.

“Look at rates among as many lenders as you can,” Selita says. “Once your credit is pulled for a loan inquiry, you actually have 30 days to apply for competitive rates without there being any additional negative impact on your credit score.”

Bottom line 

Overall, bankruptcy should not prevent you from getting a future mortgage, but you want to ensure your timing is right.

“You don’t want to rush into a financial commitment if you aren’t going to be able to afford new debt,”  Selita says. “Consider the long-term gain of potentially waiting to purchase a home until after your credit score further improves.”

Featured image by shapecharge of Getty Images.

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