Can You Refinance After Bankruptcy?
More than 700,000 Americans went through a personal bankruptcy last year, according to a LendingTree study. The result is often disastrous for their credit, which may mean higher payments for loans, including a home mortgage.
The good news? Not only is it possible to buy a house after bankruptcy, but you may be able to refinance an existing home loan. And there’s no time like the present. Even though interest rates are on the rise, they are still low by historical standards. Those who have gone through a bankruptcy don’t have to miss out on possible savings that could come with refinancing your home.
- Refinancing a home after bankruptcy: What to know
- Refinancing after bankruptcy: Chapter 7 vs. Chapter 13
- Rules for refinancing with an FHA loan after bankruptcy
- Private lender requirements for refinancing after bankruptcy
- Other hurdles to overcome
Refinancing a home after bankruptcy: What to know
Purchasing a home or refinancing a home you were able to keep during bankruptcy may not be as difficult or time-consuming as you think.
There are restrictions depending on who you are, what type of bankruptcy was filed and the type of loan you’re looking for going for. The key to refinancing after bankruptcy is knowing the rules, waiting long enough to qualify and getting your financial ducks in a row ahead of time.
Refinancing after bankruptcy: Chapter 7 vs. Chapter 13
There are two major types of personal bankruptcies:
- Chapter 7 bankruptcy – A Chapter 7 bankruptcy allows you to discharge some of your debts, with the possible exclusion of student loans, child support debt and unpaid taxes. You may be required to liquidate some of your possessions to resolve your debt, but you can usually keep your home.
- Chapter 13 bankruptcy – Chapter 13 bankruptcy requires you to restructure your debts so you can pay them off over a period of three to five years. You can typically save your home from foreclosure during this process.
Each one has a different waiting period before you can apply for a mortgage:
- Chapter 7 bankruptcy: You must wait two years after the discharge of your bankruptcy to qualify for a government-backed residential mortgage. For a conventional home loan — or one that is not backed by the federal government but conforms to loan limits set by Fannie Mae and Freddie Mac — the waiting period is four years.
- Chapter 13 bankruptcy: You are eligible one day after the discharge of your bankruptcy to qualify for a government-backed home loan. With a conventional home loan, however, you’ll need to wait two years.
Why the difference? Chapter 13 bankruptcies already have consumers repaying their debts, so the requirements are looser. You’re restructuring them instead of discharging them, so you can already prove you can repay.
One big exception. If you’ve had more than one bankruptcy — Chapter 7 or Chapter 13 — over the last seven years, there’s a five-year waiting period to refinance your mortgage or qualify for any type of home loan.
Once you get through your respective waiting period, the qualifications for a home loan are the same as anyone else. For example, you’ll need:
- Proof of income
- History of employment
- List of other debts
- Debt-to-income ratio of 50% or less for government-backed home loans and 43% or less for conventional loans
- A credit score of at least 500 for FHA loans with 10% down, 580 for FHA loans with 3.5% down, or 620 for a conventional mortgage
A note about credit. The waiting period could be a good time to rebuild your credit following a bankruptcy, efforts that may pay off when it comes to a home mortgage. The LendingTree study found that mortgage borrowers with scores between 720 and 739 three years after bankruptcy were offered comparable APRs to those without a bankruptcy, indicating that credit repairs can counteract bumps in the road. Keep reading for some steps you can take to rebuild your credit. A Chapter 7 bankruptcy can stay on your credit report for 10 years and a Chapter 13 is reported for seven years.
Rules for refinancing with an FHA loan after bankruptcy
Federal Housing Administration home loans can be a smart option for those emerging from bankruptcy due to their easy credit requirements, low down payments and low closing costs.
To qualify for an FHA home loan with only 3.5% down, you may need a credit score of only 580. If your credit score is between 500 and 579, however, you may still qualify if you can save up a down payment of 10%. You also need proof of income and employment, and these loans can only be used for a primary residence.
The fact that these loans are insured by the federal government also makes it possible for them to offer lower interest rates than those homebuyers with poor or fair credit could qualify for otherwise.
Private lender requirements for refinancing after bankruptcy
Until now, we’ve only talked about government-backed mortgages and conventional mortgages that meet Fannie Mae and Freddie Mac guidelines. However, homeowners who have gone through bankruptcy could also consider refinancing with a private lender who sets their own criteria.
Many private financial lenders don’t have the same strict lending criteria as banks. For that reason, they may be willing to lend to borrowers as soon as their bankruptcy is discharged.
In order for a borrower with a recently discharged bankruptcy to obtain a loan from a private lender, the borrower must be relatively financially stable with strong income. Borrowers typically need a relatively large down payment, too. That’s because private lenders may limit your loan-to-value ratio to 70% or 75%, compared with 97% for a government-backed loan. The higher your down payment, the lower your loan and loan-to-value ratio.
The focus is on the value of the property, and a significant down payment is what allows the private lender to overlook a borrower’s issues such as poor credit, foreclosures, loan modifications, short-sales or bankruptcies.
The value of your home — and the equity you’ve put into it — are what secure a private lender’s investment. They have more freedom to make judgments on a case-by-case basis and therefore don’t typically distinguish between the types of bankruptcy.
Still, working with a private lender may not always be ideal. While it’s a big plus to potentially avoid years of waiting to refinance your house, you’ll typically pay a much higher interest rate for a private loan. Rates may vary since private lenders are allowed to set their own terms and make decisions on a case-by-case basis, but you should compare rates before you consider this option. Also consider that fees may be higher compared with other types of home loans.
Other hurdles to overcome
Whether you decide to refinance through a private lender or government-backed loan, one of the biggest problems consumers face after bankruptcy is getting lenders to trust them again. Here are some strategies for rebuilding your credit:
Rebuilding credit after bankruptcy
One of the most effective ways to improve your credit is to pay your bills early or on time since your payment history makes up 35% of your FICO score. You should also strive to keep credit balances low since your credit utilization makes up another 30%. Paying down debt and refraining from opening new credit cards can also help you improve your credit since these factors play their own roles in how your score is determined.
It’s generally a bad idea to open an additional credit card just to increase your available credit, but if you do open a new account, a secured credit card that reports to the credit reporting agencies are a good option for building credit from scratch.
Credit builder loans are also an option for people with bad credit since they are easy to qualify for regardless of your credit history. With these loans, you basically make a loan to yourself via regular monthly payments that are reported to the three credit reporting agencies. They don’t offer a line of credit due to the way they are set up, but they can help you build credit or improve your credit score nonetheless.
Refinancing for the right reasons
So, why do you want to change your home loan anyway? Since you’re fresh out of bankruptcy, it makes sense to assess the reasons you want to refinance and whether a new home loan will actually help you.
If you’re refinancing to get a lower interest rate that could save you money, that’s generally a good move. Another smart move could involve refinancing your home to get a lower monthly payment that would increase your cash flow for other bills every month. Make sure there’s a good reason for refinancing before you go through the trouble and expense.
Straightening your finances
In addition to refinancing your home to save money on interest or lower your monthly payment, you’ll also want to spend some time getting the rest of your finances back in order. Bankruptcy was an option because your debts spiraled out of control, so you want to make sure that doesn’t happen again.
Assess your earnings and bills to make sure you’re staying on track. It may make sense to track your spending or start using a monthly budget that sets parameters for your normal monthly cash flow and expenses. You should also strive to save up an emergency fund that can cover your expenses temporarily in the case of a job loss, unexpected medical bills, surprise car repair bill or other financial setback.
Reaffirming debts and how it is seen by lenders
Many people question whether they can refinance a mortgage if they did not “reaffirm” it during bankruptcy. A reaffirmation of debts is a legal agreement between you and your creditor that you will remain liable for a specific debt and its repayment during and after bankruptcy. As long as you keep up with your payments on these debts, your creditor promises not to repossess them. A good example is a car you owe money on that you plan to keep. If you reaffirmed the debt, you would keep both the car and the car loan.
Though there may be exceptions in certain states, if you plan to keep your home after a Chapter 7 bankruptcy you will want to reaffirm your mortgage with the lender so they understand your commitment to accept the mortgage debt and keep the home. Also, if you continue making payments on the home without reaffirming the debt, it’s possible your monthly payments won’t be reported to the credit reporting agencies. If you don’t reaffirm your mortgage debt, however, you may be able to refinance down the line provided you still legally own the home.
If it’s your intent to keep the debt and pay it, then you may as well reaffirm your debts because the positive history reported to the credit bureaus will help you refinance down the line.
Instances where you would not want to reaffirm your mortgage or other debts are times when you are willing to let go of the debt via bankruptcy.
The bottom line
Refinancing your mortgage can make a lot of sense if you are able to secure a new loan with a lower interest rate, a lower monthly payment or better terms. A bankruptcy doesn’t change the benefits of refinancing, but it could slow down the process for you.
Before you refinance your mortgage after bankruptcy, make sure to ask the right questions and start rebuilding credit as quickly as you can. Also, make sure to look at different lenders so you can compare loans, interest rates and other factors. If you don’t shop around, you won’t know whether you’re getting your best loan. Since getting a better loan is probably your reason for refinancing in the first place, you could be hurting yourself if you skip this step.