Bankruptcy? There’s Still Hope
It’s not impossible to qualify for a mortgage with a Chapter 13 bankruptcy in your recent past.
Today, filing for bankruptcy is not usually a financial death sentence. In many cases, mortgage lenders will say yes to your loan application while you are still working through a Chapter 13.
Otherwise, you may need to wait a year or two after you file to qualify for a mortgage. This post will tell you how to find a lender to say “yes” to your mortgage with a Chapter 13 bankruptcy.
Bankruptcy Can Make Future Mortgages Easier To Get
Bankruptcy is a constitutional right that’s designed to help you get a fresh start following a financial disaster.
According to a New York Federal Reserve Bank study, people who file for bankruptcy get through the ordeal in better financial shape and with less damage to their credit score than those in similar financial stress who don’t file for bankruptcy.
Bankruptcy has a harsh immediate impact, but the long-term result of bankruptcy on filers’ credit scores is positive – about 60 points higher than that of consumers in financial distress who choose not to file for bankruptcy.
Chapter 7 Vs Chapter 13 Bankruptcy
Bankruptcy law is divided into chapters.
Most consumers file either a Chapter 7 bankruptcy, which discharges all qualifying debts immediately, or a Chapter 13, which sets up a three- to five-year payment plan to repay some or all of the debt.
Most mortgage lenders look more favorably on applicants who file Chapter 13 than those who file for Chapter 7.
That’s because Chapter 13 filers have made an effort to repay at least some part of their debts.
In fact, some mortgage lenders treat a Chapter 13 filing the same way that they’d consider a debt management plan through a credit counseling service — as evidence that you’re trying to fix your finances and fly right.
Credit reporting agencies favor people who file a Chapter 13 over those who file for chapter 7.
A Chapter 7 appears on a credit report for up to 10 years after the filing date, while a Chapter 13 must be removed in 7 years.
Qualifying For A Mortgage With A Chapter 13 Bankruptcy
Depending on the circumstances of your case, you may be able to qualify for a mortgage while in a Chapter 13 plan. FHA, VA and USDA (Rural Housing) lending programs do approve borrowers who are in a court-supervised payment plan.
In addition, some alternative mortgage programs (called Non-QM, Alt-A or Non-Prime) offer home loans to people in Chapter 13 plans.
The FHA, VA or USDA may approve you while in a Chapter 13 plan if:
- You qualify for the loan under the program’s underwriting guidelines.
- At least 12 months of the repayment period must have elapsed, and you must have made all required payments on time.
- The bankruptcy Trustee or a Bankruptcy Court judge gives you written approval to take out the loan.
If you have completed your plan and meet program guidelines, no additional criteria apply to get approved for government-backed mortgages.
Alternative loans for chapter 13 borrowers
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 set standards for the least risky home loans.
These are what the Act calls “qualified” mortgages.
There is no requirement that every loan meet the QM standard. Loans that don’t are considered non-QM loans, and are considered riskier than QM loans.
Lenders assume extra risks when they choose to fund these mortgages, and their costs are higher. But they me be appropriate if you want to borrow higher loan amounts or wait less time before borrowing.
Expect to pay higher interest rates and fees for one of these mortgages.
Conforming (Fannie Mae and Freddie Mac) mortgages
For conforming loans, Chapter 13 bankruptcies are treated differently depending on their cause and their conclusion.
Chapter 13 bankruptcies in which filers made all payments as required are considered “discharged.”
The waiting period required for these Chapter 13 bankruptcies is two years from the discharge date. Note that it can total seven years from the filing date before you can get a conforming loan:
- Five-year plan payment
- Additional two-year waiting period
Filers who fail to complete the plan may have their bankruptcy “dismissed.” They probably still owe their creditors, and will have to wait at least four years from the dismissal date.
Filers with multiple bankruptcies in the seven years prior to applying will have to wait at least seven years.
Conforming Loan Exceptions for Extenuating Circumstances
A two-year waiting period is permitted after a Chapter 13 dismissal, if extenuating circumstances can be documented. There are no exceptions permitted to the two-year waiting period after a Chapter 13 discharge.
For multiple bankruptcies, extenuating circumstances can get your waiting period cut to three years.
What Are “Extenuating Circumstances” For Chapter 13 Bankruptcies?
The creators of popular loan programs realize that people who file a Chapter 13 do so for good and bad reasons. An example of a “bad” reason is mismanaging money – or put more simply, living above one’s means.
Most loan program underwriters consider a “good” Chapter 13 one that was caused by extenuating circumstances. Freddie Mac offers a clear test for determining if a bankruptcy has extenuating circumstances:
- Were the events beyond your control?
- Has the problem been resolved?
- Is the problem likely to happen again?
Fannie Mae describes extenuating circumstances as “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.”
A severe illness or disability, a company layoff, or death of the primary wage-earner would likely qualify as extenuating.
Understand that these tests do not apply to every program. Talk to several lenders about your circumstances to learn when you qualify to apply for a loan following a chapter 13 discharge or dismissal.