It's not easy to refinance after bankruptcy. But, for many, it's more simple than they fear. A lot depends on the type of bankruptcy (probably Chapter 7 or 13) you've been through, whether the market value of your home still significantly exceeds the balance on your mortgage, how helpful your lender is and how fully you've regained control of your finances.
The good news is fewer consumers are having to endure bankruptcy now compared to a few years ago. There were 909,812 non-business filings nationwide in 2014, a fraction of the 1,536,799 seen in 2010, according to the Administrative Office of the U.S. Courts. Because it takes at least a year (often a few more) to emerge from bankruptcy, that means that millions of Americans are now free and clear of their old obligations. Many of those are likely to be homeowners, and quite a few of them must be eyeing today's ultra-low mortgage rates while wondering if it's possible to access them.
Refinance after Bankruptcy: Chapter and Verse
Most people file for personal bankruptcy under one of two programs: Chapter 7 or Chapter 13. Chapter 7 is more common, and involves the court imposing a liquidation in which all or nearly all (a few categories may be protected by statute) debts are wiped out. Chapter 13 sees debts reorganized, and a payment plan imposed, though the amount that has to be repaid is usually a fraction of the total sum owed.
The Federal Housing Administration (FHA) lays down rules over the minimum period between a bankruptcy and eligibility for a mortgage or refinance that it guarantees. It's important to recognize that private mortgages not backed by the FHA are not bound by these rules and may be more or less lenient, and that other credit criteria will be applied when making a decision, whether or not yours is an FHA loan. For a Chapter 7 event, you may be eligible for a mortgage or refinance providing a minimum of two years have elapsed since the date of the discharge of the bankruptcy, which is the date on which you exited the process. For Chapter 13, the FHA's website says:
A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA mortgage provided the lender documents that one year of the payout period under the bankruptcy has elapsed and the borrower's payment performance has been satisfactory (i.e., all required payments made on time). In addition, the borrower must receive permission from the court to enter into the mortgage transaction.
It's worth noting that your debts can't be discharged under a second bankruptcy filing between four and seven years of the first. That's a good thing because lenders know you – unlike those who've never been bankrupt – won't be going through the process anytime soon.
You'll Need to Get Your Finances Straight
Those FHA rules – or other ones used by private lenders – are just a first hurdle. No matter how recent or distant your bankruptcy was, nobody is going to lend to you unless you can prove your finances are back on track and you have gone some way to rebuilding your credit.
Unlike most credit events, a Chapter 7 bankruptcy can leave a black mark on your credit report for up to ten years, although a Chapter 13 one is likely to disappear after seven. And no bankruptcy sees old bad accounts wiped from your report: They remain in place (updated to show they've been "included in bankruptcy") for the usual seven years. Three years ago, The New York Times estimated that by itself a bankruptcy could wipe between 130 and 240 points off a FICO score.
But don't despair. Credit scoring systems see old bad behavior recede fairly quickly: like a near-miss traffic incident in your rear-view mirror, as a FICO executive once described it to this writer. Providing you faultlessly make prompt payments on your mortgage and any other accounts that remain open, your creditworthiness should improve month by month. You can monitor your progress using a free credit score service, such as the one offered by LendingTree, which also provides personalized advice for improving yours.
It's generally a bad idea to open new accounts, as your goal is to prove you've left behind your old borrowing habits, and can now cope comfortably with your mortgage and living expenses. However, some may argue that a single secured credit card (one where you have to deposit up front a sum equal to your credit limit, so you're not really borrowing) might help you raise your score more quickly – always providing the card you choose reports your activity to the three biggest credit bureaus.
When you're satisfied you're once again a good risk, you should expect to have to prove that to a skeptical lender. The more documentary evidence you can provide of a secure income, controlled outgoings and a disciplined household budget, the more likely you are to see your application to refinance succeed. If your bankruptcy was a result of a one-time incident that's now behind you (a family death or a divorce, maybe, or a period of illness), you can write a "hardship letter" to your lender, laying out the exceptional reasons and providing supporting documentation to prove what you're saying is true.
The "Reaffirmation" Hurdle
When you file for bankruptcy, you have the right to reaffirm certain secured debts, such as an auto loan and mortgage. This means those debts won't be discharged. Mortgage lenders often don't insist you do this, because they still retain a right to foreclose if you fall behind with payments, so a reaffirmation makes little difference to them. Regardless of what happens in court, you either pay and stay or don't and move on. However, failing to reaffirm can come back to bite you when you want to refinance.
Some lenders argue that, as the debt was discharged in bankruptcy, you don't have a balance, and therefore can't refinance. This is plain silly: In effect, you're reaffirming the debt when you refinance, and the fact you're doing so post-bankruptcy makes zero difference to them – and anyway plenty of other lenders have no problem helping borrowers in that position. However, the affirmation issue raises its head quite often, sometimes because loan officers are genuinely ignorant, and sometimes because they're willfully so: They may wish to avoid the hassle, and anyway what, from their point of view, is not to like about your paying an unnecessary high mortgage rate? If you face this, you may have to escalate your issue to your loan officer's superiors or shop around for a new lender.
One last thing: reaffirmation isn't always a smart move. If your loan is underwater (your home's market value is significantly less than the current balance on your mortgage), you might be better off leaving the shortfall as your lender's problem.
Nope, it's not easy to refinance after bankruptcy. But you might be pleasantly surprised by how straightforward it can be, and by how soon after that difficult event you may be able to access lower mortgage rates. Learn more at Your Top Mortgage Refinancing Questions, Answered.