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Getting a Mortgage After Bankruptcy: What You Need to Know

Mortgage after bankruptcy

While getting a mortgage after bankruptcy can be a challenge, it’s not impossible. Many lenders have established underwriting guidelines for borrowers who’ve emerged from bankruptcy, completed a waiting period and met other eligibility requirements.

Bankruptcy filings have declined recently, but they are still a necessary choice for some consumers who may have exhausted all other available options. If you’re searching for a mortgage after bankruptcy, it may feel like your chances at homeownership are slim. Don’t despair.

This guide will discuss how bankruptcy impacts your ability to get a mortgage, loan programs that are available post-bankruptcy and tips for getting approved.

We’ll cover:

What is bankruptcy?

Bankruptcy is a process that happens in federal courts to help consumers (and businesses) who are having extreme difficulty managing their outstanding debt. In many cases, bankruptcy involves either selling assets to repay debt or creating alternative repayment plans, and is often considered a last resort option.

There are six types of bankruptcy, but we’ll focus on two well-known types:

Chapter 7: Liquidation

This is the most common form of bankruptcy for individuals and is typically used by people who have no hope of repaying their debts. When you file a Chapter 7 bankruptcy, you’ll have to liquidate — sell — many of your assets and use the proceeds to pay your creditors. You may be able to keep assets that are protected under your state’s laws. Chapter 7 essentially allows you to make a fresh start by releasing you from all dischargeable debts.

Chapter 13: Adjustment of debts

Chapter 13 bankruptcy is designed for consumers who have a regular source of income and a desire to pay their debts but are currently unable to do so. Chapter 13 bankruptcy usually allows you to keep a valuable asset, such as your home.

In a Chapter 13 filing, you propose to the court a plan for repaying creditors. The repayment timeline is typically three to five years. If the court approves the plan, you’ll make payments to creditors through a trustee. As long as the plan is in effect, you’re protected from actions by creditors, including lawsuits and wage garnishments. Upon completion of the plan, any remaining eligible debts are discharged, or canceled, which means you’re no longer responsible for payments on their outstanding balances.

How bankruptcy affects mortgage approval

It’s obvious that your options for obtaining a mortgage after bankruptcy will be curtailed somewhat. The good news is that a bankruptcy’s impact lessens over time.

Chapter 7 bankruptcy stays on your credit report for up to 10 years, while Chapter 13 stays for up to seven years. How much it affects your credit score depends on your entire credit profile. For instance, someone with a 780 credit score may see a more than 200-point drop in their score after filing bankruptcy, according to FICO.

On the other hand, someone who already has a lower credit score may not see as dramatic of a difference, although they can expect their score to fall significantly.

When does the clock start ticking?

Waiting periods begin once the bankruptcy is discharged or dismissed, which means your case is closed and you again become responsible for repaying your debts outside of bankruptcy. For Chapter 7, the waiting period is measured from the discharge or dismissal date of the bankruptcy action.

Jason Kaplan, the owner of Mortgage Lending Associates in Bluffton, S.C., said anyone can get a mortgage after Chapter 7 bankruptcy — depending on the down payment amount and how long it’s been since the bankruptcy was discharged.

“If someone has 35% to put down on a home, they can apply for a mortgage the day after receiving their bankruptcy discharge, but the interest rates will be high,” Kaplan said. “If a borrower waits one year after discharge, they need 25% down with high interest rates. At two years, 20% down with high rates.”

For Chapter 13, the waiting period for bankruptcies that were discharged is different from those that were dismissed. The shorter waiting period based on the discharge date takes into account that borrowers working toward successful completion of a Chapter 13 bankruptcy have already spent some time working toward paying down debts and getting on better financial footing. Borrowers who were unable to complete their Chapter 13 repayment plan and received a dismissal are held to a longer waiting period.

Chapter 7 bankruptcies are removed 10 years from the filing date of the bankruptcy. Chapter 13 bankruptcies are removed seven years from the filing date. Although the credit reporting agencies should delete the bankruptcy from your credit report as soon as the seven- or 10-year waiting period ends, it’s a good idea to monitor your credit report to ensure it was removed on time.

Although you don’t have to wait for the bankruptcy to fall off of your credit report to get approved for a mortgage, it’s a good idea to ensure that it’s removed from your credit report as soon as you’re eligible, so you can start enjoying the benefits of a better credit score.

Mortgage approval waiting period after bankruptcy

Loan Type  Chapter 7  Chapter 13 
Conventional  4 years 2 years from discharge date;

4 years from dismissal date

FHA  2 years 1 year
USDA  3 years 1 year
VA  2 years 1 year

 

Why you might want to wait

Although some borrowers can be eligible for a mortgage in as little as 12 months following a bankruptcy discharge, waiting longer may be a better move.

Filing for bankruptcy has a major impact on your credit score that can’t be quickly remedied. You’ll likely only be eligible for a mortgage with a higher interest rate and may have to come up with a larger down payment. A mortgage interest rate increase of a single point can result in tens of thousands of dollars more in interest payments over the life of a 30-year mortgage, as is discussed later in the guide.

Rather than applying for a mortgage as soon as your waiting period is up, work on establishing a solid track record of on-time payments and responsible credit use. Additionally, consider taking the time to save up for a 20% down payment to avoid paying mortgage insurance. This will put you in a better position to qualify for a loan, make you eligible for a lower interest rate and ensure you’re able to manage the mortgage payments when the time comes.

How foreclosure prolongs a waiting period

Loan Type  Foreclosure Waiting Period 
Conventional  2 years from discharge date;

4 years from dismissal date;

7 years in all other cases

FHA  3 years
USDA  3 years
VA  2 years

 

A mortgage foreclosure might be the catalyst for bankruptcy for some consumers. In that case, having a foreclosure and a bankruptcy on your credit report can lengthen the waiting period for getting approved for a mortgage.

FHA loans require a three-year waiting period after either a foreclosure or a deed in lieu of foreclosure. For a conventional loan, the typical waiting period after a foreclosure is seven years. However, conventional lenders may be able to apply special provisions when the mortgage debt on a foreclosed property was discharged through bankruptcy. In that case, a borrower can be approved for a conventional loan two years after foreclosure.

Exceptions for extenuating circumstances 

In many cases, the waiting periods mentioned above may be reduced if your bankruptcy or foreclosure was due to extenuating circumstances.

Fannie Mae defines 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.”

The types of events that qualify as an extenuating circumstance vary by lender, but may include:

  • Divorce
  • Illness or death of a primary earner
  • Job loss
  • Natural disaster

If the borrower’s bankruptcy or foreclosure was the result of extenuating circumstances, the lender will require documentation to support their claim. That documentation may include a copy of a divorce decree, medical bills, notice of job layoff, job severance papers, insurance papers, tax returns, etc. The lender will also request a letter explaining the circumstances that led to the bankruptcy or foreclosure.

The waiting period may be reduced to as little as one year, depending on the mortgage program. Still, individual lender requirements vary, so it’s a good idea to discuss your circumstances with a loan officer.

Mortgage options after bankruptcy

Once you’ve satisfied the waiting period, your next step is to find a mortgage lender who is willing to work with borrowers who have previously filed bankruptcy. Fortunately, this is not as difficult as you may think.

Conventional mortgage

Getting approved for a conventional mortgage after a bankruptcy requires meeting the waiting period as outlined in the table above and demonstrating that you’ve reestablished your credit. This means paying your bills on time and keeping balances on revolving credit accounts low.

A conventional mortgage follows guidelines established by Fannie Mae and Freddie Mac, the two main government-backed agencies that buy and guarantee most of the mortgages made in the U.S. Conventional loans may have either a fixed or adjustable rate and have terms that often range from 10 to 30 years.

Conventional mortgage lenders generally require a minimum credit score of 620 and a 5% down payment, though there are some loan programs that allow a 3% down payment with income limits.

Conventional mortgage cost comparison 

To illustrate the difference between getting a conventional loan before and after bankruptcy, consider a borrower who had a credit score of 740 before declaring Chapter 7 bankruptcy. The bankruptcy was caused by a sudden illness, so it qualifies as an extenuating circumstance, and he is applying for a $250,000, 30-year mortgage two years after being discharged. He now has a 640 credit score and is making a 5% down payment.

Credit Score  APR  Monthly Payment 

(Principal and Interest) 

Interest Paid Over 30 Years 
740 3.553% $1,073.52 $148,967.20
640 4.374% $1,185.66 $189,338.47

 

In this scenario, getting a mortgage after bankruptcy will cost the borrower an additional $40,371.27 over the life of the loan because his lower credit score resulted in an annual percentage rate that is almost a full point higher.

FHA mortgage

Once the waiting period requirement is met, the FHA requires borrowers with bankruptcies to reestablish good credit or choose not to incur any new debts since the bankruptcy. Kaplan said the FHA also requires applicants to submit with their loan application a full explanation of the circumstances that led to bankruptcy.

An FHA loan is a mortgage insured by the Federal Housing Administration. These loans typically offer lending requirements that are more flexible than conventional loans. FHA loans are available in 15- or 30-year terms, and rates may be fixed or adjustable.

Borrowers with a credit score of 580 and above can get a mortgage with a 3.5% down payment. With a credit score between 500 and 579, the borrower will need at least a 10% down payment.

FHA mortgage cost comparison 

To illustrate the difference between getting an FHA loan before and after bankruptcy, we’ll consider a borrower who had a 680 credit score before filing Chapter 7 bankruptcy. The borrower’s bankruptcy wasn’t caused by an extenuating circumstance. She’s reached the two-year waiting period and is applying for a $250,000, 30-year mortgage with 3.5% down and a 620 credit score.

Credit Score  APR  Monthly Payment 

(Principal and Interest) 

Interest Paid Over 30 Years 
680 3.730% $1,114.53 $159,980.89
620 4.920% $1,283.31 $220,742.52

 

In this scenario, getting an FHA mortgage after bankruptcy would cost the borrower an additional $60,761.63 over the life of the loan.

USDA mortgage

USDA loans are backed by the U.S. Department of Agriculture (USDA) for borrowers purchasing homes in qualifying rural areas. A borrower’s income can’t exceed 115% of the median income for the area. Mortgages are fixed-rate only and have 30-year terms.

USDA-approved lenders typically require a minimum credit score of 640, with no significant delinquencies, foreclosures or bankruptcies in the past three years, although that waiting period can be reduced if the bankruptcy was due to extenuating circumstances. Additionally, it’s possible to qualify for a 0% down payment.

USDA mortgage cost comparison 

To illustrate the difference between getting a USDA loan before and after bankruptcy, consider a borrower who had a credit score of 700 before declaring bankruptcy. The borrower’s bankruptcy was caused by an extenuating circumstance, and she is applying for a $250,000, 30-year mortgage just two years after the bankruptcy discharge with a credit score of 620 and 0% down.

Credit Score  APR  Monthly Payment 

(Principal and Interest) 

Interest Paid Over 30 Years 
700 3.553% $1,130.02 $156,807.58
620 4.920% $1,329.86 $228,748.72

 

Getting a mortgage after bankruptcy would cost the borrower an additional $71,941.14 over the life of the loan.

VA mortgage

Because VA loans are focused on helping veterans buy homes, they are traditionally more lenient when it comes to a borrower’s credit history, which can be helpful if you’re trying to get a VA-backed mortgage after bankruptcy. Borrowers are eligible for a VA loan just one or two years after a bankruptcy discharge.

Service members, veterans and their families may be eligible for loans backed by the U.S. Department of Veterans Affairs (VA). VA loans don’t have a minimum credit score requirement, though many lenders may require a 620 score. VA loans are available with a 0% down payment.

VA mortgage cost comparison 

To illustrate the difference between getting a VA loan before and after bankruptcy, consider a borrower who had a credit score of 760 before declaring bankruptcy. He’s applying for a $250,000, 30-year mortgage two years after the bankruptcy discharge with a credit score of 640 and 0% down.

Credit Score  APR  Monthly Payment 

(Principal and Interest) 

Interest Paid Over 30 Years 
760 3.331% $1,099.16 $145,697.84
640 4.374% $1,248.07 $199,303.65

 

In this scenario, getting a mortgage after bankruptcy would cost the borrower an additional $53,605.81 over the life of the loan.

Tips to get approved for a mortgage after bankruptcy

If you’re trying to get a mortgage after bankruptcy, the first thing you’ll need to do is get your credit score back on track.

There is no quick fix for rebuilding your credit after a bankruptcy. However, your most recent actions have a bigger impact on your credit score than negative events from the past, so the effect that bankruptcy has on your score will diminish with each year that passes.

Keep these tips in mind to help your chances at mortgage approval.

Open a secured credit card account

A secured credit card is an easy to get and a great way to rebuild credit. You provide the bank or credit card company with a deposit, which could be $200 or more. The bank keeps your deposit as collateral and gives you a credit limit equal to your deposit. “The key is to apply for and obtain a card from a quality bank,” said Eric Klein, a bankruptcy attorney in Boca Raton, Fla. “Stay away from credit card offers with extreme interest rates.”

Klein has been helping clients through bankruptcy for more than 20 years. He said that after a bankruptcy is discharged, his clients typically receive a flood of credit card applications in their mailbox.

The secured card works like any other credit card. You charge expenses to your card, and the bank sends you a statement each month. Your credit limit, balance and payment history are reported to the credit bureau. However, if you don’t make your payments on time, the bank can take your deposit and apply it to the debt.

The key to using a secured card to improve your credit is to use the card regularly, keep your credit utilization low and pay your bill in full and on time every month. For example, if you have a secured card with a $200 limit, you could use it to buy $40 worth of gas or groceries, then pay off the balance in full when the statement arrives. This strategy will keep your credit utilization under 30%, a threshold that is often cited as ideal.

Pay bills on time

While credit cards, auto loans, mortgages and other debts are what typically come to mind when you think about payments that affect your credit score, other payments can impact your score as well.

Rent payments, utilities, medical bills, library fines, cellphone plans, gym memberships and traffic tickets can all impact your score.

If you’re regularly late on your rent, your landlord can report your delinquent payments to the credit bureaus. The other obligations mentioned above can all be referred to collection agencies, which will lower your credit score. Even if you pay the collection off, it can remain on your credit report for up to seven years.

Apply for credit cautiously

When you apply for credit, potential lenders check your credit, creating a “hard inquiry” on your credit report. Hard inquiries can negatively affect your credit score, although the impact varies from person to person based on your unique credit history.

If you’re shopping for a loan, such as a car loan, several inquiries within a short period should not negatively impact your score. Credit-rating agencies expect consumers to shop for rates, so they ignore multiple inquiries for the same type of loan made within a 14- to 45-day window, depending on whether the lender uses an older or newer FICO Score model.

However, opening several new loans or lines of credit within a short time frame can indicate that you’re having money troubles, and that can cause a greater hit to your score.

Don’t close accounts

Closing credit accounts reduces the amount of credit you have available, which increases your overall credit utilization rate and leads to a lower credit score. It’s best to keep the account open. You can cut up the card if you think you’ll be tempted to overspend.

Monitor your credit reports

After your bankruptcy and before applying for a mortgage, Klein recommends pulling a copy of your credit report from each of the three credit reporting agencies at AnnualCreditReport.com and reviewing each for inaccurate information. (You are eligible for one free report from each bureau every year.)

“When doing your analysis, make sure that all the accounts that were discharged in the bankruptcy are accurately reported as ‘Discharged in Bankruptcy’ as opposed to stating ‘Charge Off’ or any other inaccurate information,” Klein said.

Dispute any incorrect information immediately with the respective credit reporting agency.

Watch out for credit repair scams

You’ll likely receive mail from credit repair services offering to repair your credit or remove any negative information from your credit report. In most cases, these are scams. There is no quick fix for a bad credit score, and there is nothing that credit repair services can do to improve your score that you can’t do yourself.

If you need professional help managing debt or paying bills, seek out a legitimate credit counseling agency. The U.S. Department of Justice maintains a list of approved agencies.

FAQs about mortgages and bankruptcy

Can bankruptcy get rid of my mortgage debt?

The answer to this question depends on which type of bankruptcy you file. If you file Chapter 7, your mortgage debt will likely be eliminated, but this means you’ll have to give up your home unless it qualifies for an exemption. Your lender still has the right to foreclose on the home to recover as much of the original mortgage amount as possible.

With Chapter 13 bankruptcy, you’ll have a new plan to place to repay your debt, so your mortgage debt will likely stick around. Just be sure you’re making on-time payments or you’ll put yourself at risk of foreclosure.

What happens to a second mortgage during bankruptcy?

In a Chapter 7 bankruptcy filing, your second mortgage probably won’t be discharged, which means you’re still responsible for repaying it and the lender can foreclose on your home to get paid.

A Chapter 13 bankruptcy allows for “lien stripping,” which removes junior liens on your home. Since your first mortgage takes priority, you may be able to have the debt from your second mortgage discharged — once you complete your repayment plan — and have the second mortgage lien removed. This could be especially helpful if your home is underwater.

How long does a bankruptcy stay on your credit report?

A Chapter 7 bankruptcy stays on your credit report for 10 years after the filing date; a Chapter 13 stays on your report for seven years after the filing date. They will be removed automatically at the appropriate time.

What’s the difference between a bankruptcy filing date and discharge date?

The filing date is the day that you file a petition with your local bankruptcy court. The discharge date is the day you’re no longer liable for the debts included in your bankruptcy. This date could be a few months after the filing date or several years later, depending on whether you file Chapter 7 or 13.

The bottom line

It’s certainly possible to get a mortgage after bankruptcy, but it will require hard work and dedication. This will include getting your finances back on track, improving your credit score and meeting lender requirements.

Whether your circumstances require a waiting period of seven years or just 12 months, you can and should use that time to rebuild credit and improve your credit score. Not only will this improve your chances of getting approved for a mortgage when the time is right, it will also help ensure that you are financially capable of handling your monthly payments when the time comes.

Here’s what you should know about getting your credit ready to buy a home.

The information in this article is accurate as of the date of publishing. 

 

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