Bankruptcy can have a devastating impact on your finances, but that impact is not permanent. You may still be able to get a mortgage after declaring bankruptcy. You will have to complete a waiting period and show lenders that you can manage your finances well. You will also be treated as a high-risk borrower.
The good news is that you can still buy a home, and you may still make a financial recovery.
How Bankruptcy Affects Your Ability to Get a Mortgage
The bankruptcy process removes some or all of your debt and stops any collection processes, but you will pay a price for that relief. Bankruptcy will remain on your credit report for up to ten years and can have a major impact on your credit score.
Because of this, lenders may be wary about extending a mortgage to someone in or immediately following a bankruptcy.
There are several types of bankruptcy, however, and each affects your ability to get a mortgage differently.
Chapter 7: Liquidation
If you declare a Chapter 7 bankruptcy, a bankruptcy trustee will sell your assets and use the proceeds to pay as many of your debts as possible. The remaining debts will be discharged, or removed from your record. Chapter 7 bankruptcy will stay on your credit record for up to 10 years.
You can still get a mortgage after a Chapter 7 bankruptcy, however. There will be a waiting period, and you may have to make a higher than usual down payment and pay a higher interest rate.
Chapter 11: Reorganization
Chapter 11 bankruptcy is a more complicated and expensive process that is usually used by businesses. Individuals who have relatively high incomes and large amounts of debt can also use Chapter 11.
There will be a waiting period after the bankruptcy is discharged, and as with Chapter 7, you are likely to face a relatively high down payment and interest rate.
Chapter 13: Adjustment
A Chapter 13 bankruptcy provides for repayment of some or all debt over a period of three to five years under a court-ordered plan supervised by a bankruptcy trustee. When you have completed that plan, some unpaid debt may be discharged. If you don’t comply with the payment plan, the bankruptcy may be dismissed and you will still be liable for the debts.
A Chapter 13 bankruptcy remains on your credit report for up to seven years. Your bankruptcy trustee will have to approve any mortgage application during the repayment period.
Mortgage Loans After Bankruptcy
Bankruptcy affects different types of loans in different ways. There are minimum waiting periods for each type of bankruptcy and each type of loan. Individual lenders may impose stricter requirements.
Conventional Loans
Conventional loans are not insured by any government agency. To get a conventional loan after bankruptcy, you may have to pay for mortgage insurance until your equity is above 20% of the initial mortgage.
If your bankruptcy was under Chapter 7 or 11, you’ll have to wait 4 years after your bankruptcy is discharged to apply for a conventional mortgage. This may be reduced to 2 years if the bankruptcy was caused by factors you can’t control, like medical expenses or a job loss.
You’ll have to wait two years after a Chapter 13 discharge or four years after dismissal before applying for a mortgage.
FHA Loans
FHA loans are managed by the Federal Housing Administration. The down payment may be as low as 3.5% if your credit score qualifies, but you will have to pay for mortgage insurance, which makes monthly payments higher.
FHA loans require a two-year waiting period after a Chapter 7 bankruptcy, which may be reduced to one year if the bankruptcy was caused by factors beyond your control. You will have to show that you’ve managed your finances responsibly since the bankruptcy.
You can apply for a mortgage one year after a Chapter 13 bankruptcy if you follow your court-ordered payment plan. You will need the approval of your bankruptcy trustee.
There is no mandatory waiting period for an FHA loan after a Chapter 11 bankruptcy.
USDA Loans
The US Department of Agriculture guarantees loans for borrowers who meet their income requirements. The program is designed for rural homebuyers, but some suburban areas are also covered. USDA loans offer low interest rates with no down payment.
You will have to wait three years to apply for a USDA loan after a Chapter 7 bankruptcy, or one year if the bankruptcy was caused by circumstances beyond your control. After a Chapter 13 bankruptcy, you will have to follow your payment plan for one year before applying for a mortgage.
There is no mandatory waiting period for a USDA loan after a Chapter 11 bankruptcy.
VA Loans
The Department of Veterans Affairs (VA) provides loans for individuals who have served or are currently serving in the military. These loans do not require down payments or mortgage insurance and carry very low interest rates. You will have to pay a percentage of the home price as a funding fee.
You’ll have to wait two years after the discharge of a Chapter 7 bankruptcy or one year from the discharge date of a Chapter 13 bankruptcy to apply for a VA loan. There’s no mandatory waiting period after a Chapter 11 bankruptcy.
If you have purchased a home with a VA loan before and lost it to foreclosure, you will have to pay back any money owed to the VA before applying for a new loan.
Why Is There a Waiting Period for a Mortgage After Bankruptcy?
The waiting period (sometimes called a seasoning period) between bankruptcy and a mortgage application is not a punishment. It’s there to give you a chance to recover your finances, rebuild your credit, and practice good financial management.
Waiting periods for some loans are shorter if your bankruptcy was caused by events outside your control, such as medical bills, a job loss, a divorce, or a natural disaster. You will need documents showing that your bankruptcy was not caused by financial mismanagement.
A foreclosure can also affect your waiting period. FHA loans require a three-year waiting period after a foreclosure. For conventional loans, the waiting period may be as long as seven years. This waiting period may be reduced if the foreclosure occurred before the bankruptcy and the mortgage debt was included in the bankruptcy discharge.
If you have filed for more than one bankruptcy in the last seven years, the waiting period for any mortgage will be five years from the latest discharge date. This may be reduced to three years if the bankruptcies were caused by events you could not control.
How to Prepare for a Mortgage After Bankruptcy
Getting a mortgage after bankruptcy is never easy. You will have to show lenders that you are managing your finances responsibly and that you’ve solved the problems that caused your bankruptcy.
You can start preparing for the recovery process during your bankruptcy proceeding. Be sure that the bankruptcy is fully discharged and complete, and that you comply with all requirements. Keep all records related to your bankruptcy. When the bankruptcy is discharged, check your credit report to be sure all debts included in the discharge have been removed.
Establishing a good financial record during your waiting period can make a positive impression on lenders. Pay all of your bills on time and reestablish credit if possible.
If your bankruptcy is under Chapter 13, comply with your court-ordered plan and make all payments on time.
When you are ready to apply for a mortgage, talk to different lenders and see what terms they’re prepared to offer. Be prepared to discuss your bankruptcy honestly. You will probably need to explain what happened and what you’ve done to make sure it won’t happen again
If waiting a little longer to buy a home could put you in a better financial position, consider waiting. A small difference in mortgage terms can add up to a lot of money.
Bankruptcy Is Not Forever
Bankruptcy can seem like a permanent exile from financial life. That’s not what it’s intended to be. The purpose of bankruptcy is to give you a fresh start and a chance to get your finances in order without the burden of your previous debts.
You can recover from bankruptcy and you can buy a home after bankruptcy, but you’ll need to start small, manage your money well, and monitor your credit. If you manage your finances effectively, you’ll soon be on the road to recovery, and that road can lead you to a new mortgage and a new home!
