Getting a mortgage after a bankruptcy isn’t just possible; it doesn’t take as long as many borrowers think. There will be a mandatory waiting period, unless you are applying with a non-QM lender, before you can qualify for a mortgage after a bankruptcy. One of the most forgiving providers of a mortgage post bankruptcy is the Federal Housing Administration (FHA.) FHA is the part of Housing and Urban Development (HUD) that insures the mortgage. This government insurance allows for more aggressive guidelines compared to its Conventional counter parts; Fannie Mae and Freddie Mac. The bankruptcy seasoning time is determined by the type of bankruptcy that has been declared. FHA Loan after a Chapter 7 Bankruptcy
An over simplified definition of a Chapter 7 bankruptcy is: a liquidation of your assets to pay off your debts or at least as much as you can. This leads to the discharge of the balance, if any, of those debts. Of course, there are exceptions, exclusions and reaffirmations of debts. A bankruptcy trustee can authorize the liquidation of property that isn’t protected in my aforementioned list to pay back some or all of the debts owed to creditors. In exchange, eligible debt is discharged completely. After a Chapter 7 bankruptcy discharge, you are no longer responsible for the debt and the borrower, from a debt stand point, get’s a fresh start. You may be eligible for an FHA loan 24 months from your Chapter 7 bankruptcy discharge date. FHA guidelines do offer an exception to this waiting period which shortens the seasoning time to just 12 months using the “Back to Work Program” if you can show that your bankruptcy was due to “extenuating circumstances” such as the death of the primary earning spouse, serious illness, or natural disaster that caused you to lose everything. These exceptions are reviewed case-by-case and loan decision is issued at the underwriter’s discretion. Most people are not eligible for an exception. FHA Loan after a Chapter 13 Bankruptcy
A Chapter 13 bankruptcy, otherwise known as a “wage earners plan,” allows the bankruptcy petitioner, with the approval of a court-appointed trustee, to develop a plan to repay all or part of their debts. The repayment plan typically is for 3 to 5 years. When this payment plan is completed, the remaining debts, if any, will be discharged. Unlike Chapter 7, a Chapter 13 bankruptcy typically allows you to keep sizable assets like a home, two or more vehicles, and other assets. To be eligible for an FHA loan after filing a Chapter 13 bankruptcy, you must have made all payments under the payment plan timely for at least 12 months. You will also need to provide documentation of your payment history to the lender as well as get approval from the bankruptcy trustee to secure a new mortgage. The trustee will need the specific terms of the proposed mortgage including the monthly payment and funds needed to close to ensure that the borrower is not overextending himself. It’s important to know that an approval by a lender doesn’t guarantee an approval by the trustee.
Qualifying for a Second FHA Mortgage after Defaulting on the First
If you had a previous FHA mortgage and defaulted on the loan, you may fail the CAIVRS screening system when you apply for a new FHA loan. The Credit Alert Interactive Verification Reporting System is a federal database of people with delinquencies on any federal debt, including but not limited to federal student loans, FHA loans, and VA loans. If a lender considering you for an FHA loan finds you were delinquent on a prior FHA loan or another government-backed mortgage, your application can be denied. Borrowers are not eligible for FHA loans if they are listed on the CAIVRS system unless they have entered an approved repayment plan. However, there are exceptions. If you declared bankruptcy and the property in question was included in your bankruptcy, you can be eligible for another FHA or other government insured loan if you can show that the bankruptcy was due to “extenuating circumstances.” As with the “Back to Work Program,” this is not easy to qualify for this option. Getting Approved for a Mortgage after Bankruptcy
In addition to the waiting period before you can qualify for a FHA mortgage, there may be other conditions that need to be met before applying for a FHA loan. Welcome to the world of “overlays.” Overlays are guidelines the lender requires that are in addition to those of FHA, Fannie Mae, Freddie Mac, VA or USDA. This is in part because the FHA penalizes lenders that approve too many “bad” FHA mortgages, even if the borrowers default years later. Lenders who have too many poorly performing loans compared to other lenders can even risk being removed from the list of FHA-approved lenders. Lenders will mitigate the risk of a borrower defaulting by applying overlays which in turn raise the standards for what the lender deems as a qualified borrower. A common overlay is tied to credit scores.
FHA requires a credit score of 580 or higher to qualify for 96.5% financing. A score between 500 and 579 allows for a maximum LTV (loan to value) of 90%. It is common for lenders to have an overlay requiring a minimum credit score between 600 and 640. Other common overlays are: a minimum of 3 trade lines, 3 years seasoning post bankruptcy or a maximum debt to income ratio of 45%. This is where it gets tricky. Per HUD’s guides, you are not required to re-establish credit to qualify for a new FHA loan. The guideline reads as follows: The borrower must have re-established good credit; OR chosen not to incur new credit obligations. However, you may need to re-establish credit to get your score to where you need it to be to meet the minimum score requirement for your desired loan to value. There is no doubt that a bankruptcy will lower your scores. How low your scores go will be based on both your derogatory accounts as well as the accounts that were not included in your bankruptcy. It’s not uncommon for a borrower to have a 600 score 1 day after a bankruptcy discharge. It is important to review your credit score and credit profile post bankruptcy to come up with
a plan to meet the score minimums for your down payment objectives in the case of a purchase or your loan to value restrictions if you need to refinance. Most credit reporting companies offer a FICO simulator to loan officers to help them establish a plan for credit score improvement. How an FHA Loan Compares to Other Loan Programs
Every type of mortgage has its own seasoning requirement after a bankruptcy discharge or in the case of a Chapter 13 and FHA, filing date. While an FHA loan requires 1-2 years, depending on the type of bankruptcy, a conforming mortgage usually requires four years. VA home loans only require two years after a bankruptcy to qualify, like an FHA loan, while a USDA loan, which is also backed by the government, requires three years. As I mentioned earlier, there are Non-QM (private lenders) that offer loans with no seasoning requirement. These loans are typically at a rate much higher than the current market rates and are offered at a reduced loan to value.