Getting A Mortgage After Bankruptcy

While bankruptcy may negatively impact your ability to obtain a mortgage, it is possible to qualify for a mortgage after filing for bankruptcy.

The bankruptcy, which is listed in the public record information section of a credit report, remains for seven years from the filing date of a Chapter 13 bankruptcy, or ten years from the filing date of a Chapter 7 bankruptcy.

If you can wait that long to obtain a mortgage, your credit report will not mention your bankruptcy. If you cannot wait for your bankruptcy to disappear from your credit record, you will need to wait some period of time and, during that waiting period, rebuild your credit and save up for a down payment.

The Waiting Period

The length of the waiting period will depend upon whether you filed a Chapter 7 or a Chapter 13 bankruptcy and the type of mortgage you are applying for.

Conventional Lenders

In general, if you filed a Chapter 7 bankruptcy and you are applying for a conventional Fannie Mae or Freddie Mac mortgage, you will have to wait a minimum of two years following the discharge date before you will be eligible for a mortgage, provided certain conditions, described below, are satisfied. If you filed a Chapter 13 bankruptcy and you are applying for a conventional Fannie Mae or Freddie Mac mortgage, the minimum waiting period could be as little as one year following the discharge date before you would be eligible for a mortgage, provided certain conditions, described below, are satisfied. There may be more lenient conditions if you are eligible for an FHA or VA mortgage, described below. However, if your bankruptcy involved a foreclosure or deed in lieu, the waiting period could be a year longer. Also note that certain lenders may impose longer waiting periods than the mortgage agencies’ guidelines.

Subprime Lenders

Nothing prohibits you from seeking non-government backed mortgage financing one day after your bankruptcy discharge date. Subprime lenders, also known as “B-C-D” lenders, provide mortgage financing for people who do not qualify for a conventional mortgage, but at a steep price. The down payment and interest rate required by a subprime mortgage lender may be considerably higher, and the loan-to-value ratio considerable lower, than that required by a conventional, government-backed mortgage lender. Subprime lenders typically make loans six months after a bankruptcy discharge, but will a require a 15% to 30% down payment plus closing costs, charge an interest rate of 9% to 15% (which may be an adjustable rate), and impose other conditions, such as a minimum FICO credit score of 580 and no late payments on your rental history for the last 12 months.

Considering that you will be paying interest on the new mortgage for up to 30 years, you will save a lot of money by waiting to qualify for a conventional mortgage.

Alternative Arrangements

An alternative to buying a home with a mortgage that would eliminate the waiting period would be to buy a home with seller financing. Seller financing can be much more flexible than a conventional or subprime mortgage. If you choose this option, remember to allow for refinancing with a conventional mortgage as soon as you are eligible in the seller-financed loan agreement.

Another possibility would be to lease a home with an option to buy. Perhaps you could apply part or all of the monthly lease payments towards the purchase price of the home. Structure the lease to cover the expected waiting period, so that after the lease period ended, you would be eligible for a conventional mortgage.

A possible way around the bankruptcy limitations may be to ask a family member or close friend with excellent credit to co-sign the mortgage loan. A co-signer guarantees to make the mortgage payments in the event that you do not. That is an enormous favor to ask someone, so you should have a very stable income and be back on track financially before asking.

During the waiting period, you have an opportunity to rebuild your credit record so that you can get a mortgage on the most favorable terms.

Applying For a Mortgage

While rebuilding your credit is a critical factor in applying for a mortgage, there are other important factors as well, including employment history, debt-to-income ratio, down payment and understanding the requirements of the various government mortgage agencies.

Employment History

Mortgage lenders want to know that you have a stable source of income. So, try to maintain your current job and salary for at least one year, if not the entire waiting period.

Debt-to-Income Ratio

Mortgage lenders consider your debt-to-income ratio (“DTI”) to be a key indicator of your ability to make mortgage payments. The lower your total debts are as a percentage of your annual income, the greater your ability to make mortgage payments. By eliminating your unsecured debts, bankruptcy, especially a Chapter 7 bankruptcy, causes your DTI ratio to improve.

Down Payment

Down payments protect mortgage lenders against declines in property value as well as non-payment. The more money you save for a down payment, the less money you will need to borrow. Saving even more than you need for a down payment shows the lender additional financial responsibility.

The average down payment is 3%, but in a post-bankruptcy situation, more may be required by the lender. A higher down payment may allow you to secure a lower interest rate and better terms.

Besides saving money in the bank, you may be able get a down payment from relatives by gift or loan, or through a down payment assistance program, such as the Connecticut Housing Finance Authority Downpayment Assistance program and the New York City Department of Housing Preservation and Development HomeFirst Down Payment Assistance program.

Understand the Qualifications for Fannie Mae, Freddie Mac, FHA & VA Mortgage Loans

Once you have rebuilt your credit and waited the applicable time period, you can apply for a mortgage. Be prepared to provide potential lenders with lots of information, including two-years of tax returns, recent paycheck stubs, banking account information, bankruptcy discharge papers, a list of liquid assets, and a written explanation of the financial issues that led up to your bankruptcy, and what you have done to avoid such difficulties in the future.

In general, Fannie Mae and Freddie Mac require a waiting period of four years following the bankruptcy discharge or dismissal date; however, with extenuating circumstances these lenders will approve mortgages on a case by case basis after two years.

Fannie Mae requires a four-year waiting period after a Chapter 7, measured from the discharge or dismissal date of the bankruptcy action. It will permit a two-year waiting period if extenuating circumstances can be documented.

Fannie Mae distinguishes between Chapter 13 bankruptcies that were dismissed or discharged. Fannie measures the waiting period required for chapter 13 bankruptcy actions as follows: (i) twoyears from the discharge date, or (ii) four years from the dismissal date. According to Fannie Mae, the shorter waiting period following a discharge gives borrowers some waiting period “credit” for the time needed for the successfully complete a Chapter 13 plan and receive a discharge. A foreclosure can add an extra year.

Both agencies include provisions for “extenuating circumstances,” which, if met, reduce the required waiting periods — to two years on a bankruptcy and three years on a foreclosure.

Extenuating circumstances are credible excuses for the bankruptcy or foreclosure that demonstrate that the likelihood of a recurrence is very low. The case is made in what lenders call a “cry letter,” which is included in the borrower’s application. The extenuating circumstances must be a nonrecurring or isolated circumstance, or set of circumstances that: (i) were beyond the borrower’s control; (ii) significantly reduced income and/or increased expenses; and (iii) rendered the borrower unable to repay obligations as agreed, resulting in significant adverse or derogatory credit information.

Lenders typically look for a number of reasons that explain the bankruptcy and/or foreclosure, including job loss, illness, accident, death in the family, victimization by fraud; etc. The borrower must also document that those events are unlikely to recur and the borrower’s capacity to handle financial affairs has improved. A rising credit score and an ability to make a significant down payment help make that case. Lending officers and mortgage brokers can help borrowers craft the letter, because they know what the underwriters are looking for.

Freddie Mac’s bankruptcy rules are very similar to Fannie Mae’s, although Freddie documents its rules differently. If the bankruptcy filing was the result of a one-time occurrence, such as the death of a spouse, divorce or illness, the waiting period to apply for a mortgage may be reduced. Lenders will often want borrowers to write a hardship letter explaining their situation, backed by documentation like hospital bills or a court-approved divorce settlement.

The Federal Housing Administration (FHA) specializes in insuring loans for qualified borrowers who have issues that exclude them from conventional loan programs, including less than perfect credit histories. FHA loan guidelines do not require a minimum credit score, though participating FHA lenders might. FHA’s rules on bankruptcy, foreclosure and extenuating circumstances are more liberal than those of Fannie and Freddie.

As long as two years have passed since the Chapter 7 bankruptcy discharge date, and good credit habits have been restored, the borrower may receive an FHA mortgage. However, after 12 months following a Chapter 7 discharge, the FHA may approve an application if the borrower can show three things: (i) the bankruptcy was caused by extenuating circumstances beyond his or her control, such as the death of the principal wage earner, or a serious long-term uninsured illness; (ii) an ability to manage his or her personal finances in a responsible manner; and (iii) the events leading to the bankruptcy are not likely to recur.

A person who has received Chapter 13 discharge must 24 months before they can apply. However, the FHA may approve an application, before the discharge and after only 12 months, if the borrower can prove three things: (i) one year of payments under the Chapter 13 plan have been made on time; (ii) no other late payments have been made on any other debts; and (iii) the borrower received written permission from the Chapter 13 trustee to enter into the mortgage transaction.

FHA insured mortgages are generally not available to borrowers whose property was foreclosed on or given a deed-in-lieu of foreclosure within the previous three years. However, if the foreclosure of the borrower’s main residence was the result of extenuating circumstances, an exception may be granted if they have since established good credit. This does not include the inability to sell a home when transferring from one area to another.

Like the FHA, the Veterans Administration (VA) accepts applications from borrowers who have had a Chapter 7 or 13 bankruptcy discharged more than 2 years earlier. The VA will consider an application with a bankruptcy discharged 12 to 24 months earlier if: (i) the borrower reestablished a satisfactory credit profile, and (ii) the bankruptcy was caused by circumstances beyond the borrower’s control.

An experienced mortgage broker with access to many lenders will likely know which ones will approve you for a mortgage after bankruptcy and what interest rate and down payment you will have to pay. In addition, they will be able to help you in compiling all the information for the mortgage application.