How to Qualify for an FHA Loan After Bankruptcy
Sometimes life deals you a bad hand. Job loss, the death of a spouse, natural disasters and unexpected expenses can push you dire financial straits that only bankruptcy can remedy. If you’re considering bankruptcy or recently went through one, you may wonder how long it will take to recover. You’ve likely heard that a bankruptcy will stay on your credit report for seven to 10 years. While that is true, you may actually be able to bounce back from bankruptcy much sooner than that and even go on to become a homeowner with the help of an FHA loan.
FHA loans after bankruptcy
FHA loans are offered by individual lenders and insured by the Federal Housing Administration, meaning the government guarantees that it will repay the loan if the borrower stops making payments. This guarantee means lenders are willing to provide mortgages to borrowers who might not otherwise be able to qualify for a home loan.
While you can get an FHA loan after bankruptcy, the timeline depends on the kind of bankruptcy you declared. There are two types of bankruptcy available to individuals, and each comes with its own waiting period for getting an FHA loan.
Chapter 7 bankruptcy involves liquidating property, using the proceeds to pay creditors and eliminating all remaining eligible debt. This is the most common kind of bankruptcy for individuals and is usually the best option for people who have so little income that they have no hope of being able to repay their debts.
You are eligible for an FHA loan after Chapter 7 two years after discharge (the court order that releases you from liability for the debts included in the bankruptcy). During those two years, you must have re-established good credit and avoided taking on additional debt.
According to official FHA loan guidelines, you may be eligible for an FHA loan just 12 months after the discharge of a Chapter 7 bankruptcy if you can demonstrate that the bankruptcy was caused by circumstances beyond your control. Those extenuating circumstances might include the death of a breadwinner spouse, a serious illness, getting laid off or a natural disaster that caused you to lose everything.
However, Jeremy Schachter, Branch Manager of Fairway Independent Mortgage Corp. in Phoenix, said those exceptions are few and far between. “It’s taken on a case-by-case basis at the discretion of the underwriter,” Schachter said. “Don’t rely on that exception unless something truly catastrophic happened. The majority of people won’t fall into that category.”
Chapter 13 bankruptcy is reserved for individuals who have a regular source of income and the desire and ability to repay at least some of their debts. In a Chapter 13 filing, the debtor works with a trustee on a plan to repay creditors over a three- to five-year period. Upon completion of the payment plan, any remaining eligible debts are discharged.
Chapter 13 bankruptcy usually allows an individual to keep their home, vehicle, and certain other assets.
To be eligible for an FHA loan, you must have made payments to the payment plan for at least one year. You’ll have to provide documentation showing all required payments have been made on time and get written permission from bankruptcy court to enter into the mortgage transaction.
|Getting an FHA loan|
|Minimum credit score||500|
|Income requirements||No minimum or maximum. Borrowers must have “sufficient income to qualify for the mortgage payment and other debts.”|
|Debt-to-income ratio||Typically 43%, although approval with a DTI up to 50% is possible for borrowers with higher credit scores and/or higher cash reserves.|
|Property requirements||The property must not be hazardous or threaten the health and safety of the occupants. Requirements are outlined in detail in HUD’s Single Family Housing Policy Handbook.|
Improving your finances
In addition to the waiting periods outlined above, you’ll also need to demonstrate that you’ve re-established good credit to get an FHA loan after bankruptcy.
Bankruptcy is one of the most detrimental things you can do to your credit score, but its impact depends on your entire credit profile. Someone with a score in the mid-700s might see their score drop by 100 points or more, while someone who already has a low credit score due to a history of mismanaging their credit might not see a dramatic difference.
The good news? According to a recent Lending Tree study, 43% of people who’ve gone through bankruptcy have a credit score of 640 or higher within a year of the bankruptcy. Within two years, 65% of people have such a score.
No matter where your credit score was pre-bankruptcy, you’ll need to take steps to improve your finances, reestablish your credit and demonstrate that you can manage your finances wisely after declaring bankruptcy and before applying for an FHA loan.
To improve your finances after bankruptcy:
Getting in the habit of saving money can help you realize your dream of homeownership after bankruptcy in several ways. First, establishing an emergency fund can help you avoid relying on credit cards when unexpected expenses arise.
Second, when you are ready to apply for an FHA loan, you’ll need to come up with:
- A down payment. The benefit of FHA loans over many other loan programs is that you can get an FHA loan with a down payment as low as 3.5%. However, borrowers with credit scores below 579 will need at least 10% down.
- Closing costs. The type and amount of closing costs you’ll pay varies depending on your lender and your location. But you can generally expect to pay anywhere from 2% to 7% of the home’s purchase price in closing costs.
- Cash reserves. FHA loans require borrowers to have enough cash reserves to cover at least one monthly mortgage payment after coming up with a down payment and closing costs.
Apply for a secured credit card
Immediately after your bankruptcy, you might have a hard time qualifying for a new credit card, but opening a new credit account and using it responsibly can help you improve your score.
Schachter recommended getting a secured credit card if you can’t get approved for a traditional credit card.
With a secured card, you give the bank or credit card company a deposit, generally $200 or more. The bank keeps that deposit as collateral and gives you a card with a credit limit equal to your deposit. You then use it like a regular credit card, but if you don’t make your payments on time, the bank can take your deposit.
The key to improving your credit with a secured card is to use it regularly, keep your balance low and pay your bill in full and on time every month.
Pay your bills on time
Your payment history accounts for 35% of your FICO score calculation, so make every effort to pay your bills on time. Set up payment reminders or enroll in automatic payments through your bank or lender to ensure you’re not delinquent again.
Avoiding any late payments on your credit report, especially in the 12 months leading up to applying for an FHA loan, is really critical after bankruptcy. “A lot of times, people go through bankruptcy, and then they pay their bills late again,” Schachter said. “Lenders want to see you’ve learned a lesson. If you’re late on debt payments after bankruptcy, it’s a huge red flag.”
Keep balances on revolving credit accounts low
Whenever you use revolving credit accounts, use them sparingly. The amount you owe on these accounts makes up 30% of your FICO score calculation.
The lower your credit utilization rate (how much of your available credit you use), the better, as far as your credit score goes. A good rule of thumb is to keep your credit utilization rate below 30%, both on a per-card basis and overall — for example, if you have a secured credit card with a limit of $500, you should charge less than $150 (30% of $500) in any given billing period, then pay off the statement balance in full.
Don’t open a lot of new accounts
The average age of all of your credit accounts makes up about 15% of your FICO score calculation, and new accounts make up 10%. Opening several new accounts within a short period of time lowers your average account age, and the numerous hard inquiries into your credit report may lower your credit score. Only apply for new credit when absolutely necessary.
After a bankruptcy, you might think homeownership isn’t an option, or that the only home loans you’ll be able to get will come with extremely high-interest rates. But if you get past the FHA bankruptcy waiting period and rebuild your credit score, you may have access to the same FHA loans and interest rates as anyone else.
“A borrower with a 700 credit score and a bankruptcy on their credit report would get the same rate as someone without a bankruptcy on their file,” Schachter said.
Filing for bankruptcy has a significant impact on your credit score. Depending on how much your score was impacted by the bankruptcy, it may take a while to rebuild your score, save money for your down payment and get in the habit of consistently paying your bills on time. It could take longer than the one- or two-year waiting periods, but you won’t be excluded from homeownership for the entire time the bankruptcy appears on your credit report.
“Life happens,” Schachter said. “Don’t feel discouraged that you’ll never own a home again.”