Bankruptcy can seem like the end of the world to people who undergo the experience but the reality is that you can recover from it and even go on to become a homeowner within a year or two with the help of an FHA loan. Whether your bankruptcy became a necessity because of the global financial crisis and long-term unemployment, due to a divorce, an illness, or financial mismanagement will make a difference in how quickly you can qualify for a new mortgage. No matter what the reason was, however, your path to financial success requires perseverance and knowledge of the requirements for an FHA loan.
FHA loans and bankruptcy
FHA loans, insured by the Federal Housing Administration and approved by individual lenders, offer the quickest path to homeownership after a bankruptcy. FHA guidelines under normal circumstances allow you to apply for a new mortgage two years after a Chapter 7 bankruptcy and one year after a Chapter 13 bankruptcy. However, some exceptions can be made if the financial issues that caused the bankruptcy can be tied to a single incident such as the death of a spouse or a medical emergency.
The FHA also introduced their "Back to Work – Extenuating Circumstances" loan program specifically for loan applications made between August 15, 2013 and September 30, 2016 to ease the requirements for potential homebuyers who experienced hardship due to the recession. Through that program, qualified applicants can obtain a mortgage just one year after a Chapter 7 bankruptcy.
To qualify for the Back to Work program, you need to:
- Prove that you experienced a job loss or a severe reduction in income of 20 percent or more for at least six months
- Demonstrate that you are employed and can afford new loan payments
- Have had a satisfactory credit score prior to your financial event, with no late payments or major delinquency
- Have a satisfactory credit score for the past 12 months, with no late payments and no collection accounts unless they are related to identity theft
- Complete a one-on-one housing counseling session with an approved housing counselor to discuss the cause of your bankruptcy and what you have done since the bankruptcy to improve your finances and reduce your chances of a recurrence of financial problems
While the FHA has established these guidelines, individual lenders also have their own guidelines that they can set in order to approve you for a loan. Lenders are willing to work with you if you can clearly document your income, your assets and your ability to repay the loan. If you have a bankruptcy in your past, you'll need to prove to your lender it was an exception to your usual financial responsibility and not a pattern. If your bankruptcy was caused by financial mismanagement, it could take a little longer to prove to a lender that you are a worthy borrower.
Improving your financial profile
Immediately after your bankruptcy and through the time you are applying for a mortgage you should take steps to re-establish your good credit and to manage your money wisely.
- Begin saving money as soon as possible so you will have the cash you need for a down payment, closing costs and cash reserves. An FHA loan requires a down payment of just 3.5 percent, which is $7,000 on a $200,000 loan. In addition to needing the cash, establishing a pattern of saving money will help you adjust to paying your future mortgage and show a lender that you have financial discipline.
- It may seem counterintuitive to open a credit card account when you want to avoid debt, but in order to improve your credit score you need to take on a little debt and repay it on time. You may need to take out a secured credit card at first after a bankruptcy. If you do, make sure your payments are being reported to the credit bureaus.
- Make sure you pay all your bills on time and in full because a lender can ask to see your rent payment history and your utility bills, too. Avoid taking on extensive debt because a lender will be wary that you won't be handle your obligations.
- When you're ready to apply for an FHA loan, make sure you are applying for a loan that you can comfortably afford. While you may be able to qualify with a debt-to-income ratio of 45 percent (meaning that your minimum monthly payments including the new mortgage equals 45 percent or less than your monthly gross income), the lower your debt-to-income ratio, the easier it will be to qualify for a loan and the easier it will be to keep up with on-time payments.
While following these steps won't guarantee that your FHA loan is approved, it will go a long way to improving your chances that a lender will say yes to your FHA mortgage application.