Are you considering a home equity loan but are concerned that your recent bankruptcy is holding you back? Having a bankruptcy on your record won't necessarily prevent you from using home equity; however, it could be difficult to find a lender willing to approve your application. Here are several things you'll want to know about applying for home equity loans after a chapter 13 bankruptcy.
Home Equity Loan Vs Home Equity Line of Credit
Depending on your needs and regardless of how bad you think your recent bankruptcy was, you'll want to consider the benefits of these types of home loans. What's the difference? Think of a home equity loan as a second mortgage. Once approved, you'll receive a lump sum all at once for the amount you're borrowing.
Your HELOC on the other hand, allows you the freedom to choose when and exactly for what your home equity will be spent. Your home equity line of credit may even come with a debit card which when used carefully can help prevent over borrowing.
HELOC loans usually come with a 25-year term length including the draw and repayment periods. The draw generally lasts for the first 5-10 years and you can spend up to your credit line amount making interest-only payments on the amount you've spent.
The interest rate for your HELOC is usually based on the prime interest rate plus the lender's margin based on your average daily balance. Once your draw period is complete you must start paying down the principal balance and can expect your monthly payments to go up. At this point your loan HELOC is basically a second mortgage. Some HELOCS may carry balloon payments which could put you in a tight spot if you're having trouble getting the cash to make the payment.
Doesn't My Chapter 13 Bankruptcy Make Me a Bad Credit Risk?
Having a recent bankruptcy on your record doesn't necessarily make you a bad risk for creditors. After all, you can't file to discharge any of your debts for another eight years. With Chapter 13 you may be required to wait 2 years from the date your bankruptcy was discharged or 4 years from your dismissal date. Having a chapter 13 bankruptcy on your record could make finding an approval time consuming as each lender has their own criteria for approving your loan.
Downsides of a Home Equity Line of Credit
Many homeowners are apprehensive of getting a HELOC in addition to their first mortgage. Because HELOCs often come with a debit card as a convenience, it's all too easy to spend money on things you probably wouldn't otherwise purchase. Also, because HELOCs come with adjustable interest rates and typically do not have periodic caps, you risk payment shock when the lender adjusts your payment amount. You may also encounter prepayment or early closure fees or pay penalties if you don't meet minimum draw amounts.
Remember the behaviors that led up to your chapter 13 bankruptcy could get you into trouble with a home equity loan or HELOC. Even though these loans are secondary to the mortgage you used to purchase your home, falling behind on the payments could lead to foreclosure and eventually losing your home.