How to Get a Mortgage After Bankruptcy

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Bankruptcy devastates your finances, and its negative mark can stay on your credit report for as long as ten years. That means qualifying for a mortgage post-bankruptcy is difficult but not impossible over time.

You’ll need patience and be smart about making finances that will gradually boost your credit score so you can eventually qualify for a mortgage again.

The Differences Between Chapter 7 and Chapter 13 

Chapter 13 Bankruptcy

When past-due statements are piling up, and you don’t want to lose the house, a Chapter 13 bankruptcy might be the right solution.

Many people experiencing financial difficulties first try to refinance their mortgage as a means of debt relief. Unfortunately, mortgage markets aren’t as welcoming as they used to be, and refinancing could be a challenge, particularly for less qualified applicants.

For those people, a Chapter 13 bankruptcy may be a good alternative. This option is appealing to homeowners because it allows them to avoid foreclosure, unlike a Chapter 7 bankruptcy, which generally results in liquidating the debtor’s property, including real estate.

Chapter 13 bankruptcy is best suited for gainfully employed individuals with temporary economic setbacks. It isn’t going to wipe away the debt, but it will allow for short-term debt reorganization. As part of the filing process, the debtor must create a plan to repay the past-due bills within three to five years. 

While making those payments, the debtor must also stay current on all other bills that come due. Meanwhile, the court prohibits creditors from pursuing collections or legal proceedings, including foreclosure.

Chapter 13 has its disadvantages, however. Debtors who can’t afford their current mortgage payments aren’t suitable candidates. This excludes many homeowners who are caught in overpriced, adjustable-rate mortgages.

The court also expects that a borrower’s excess cash flow will go towards the debt repayment. So, debtors have little budget room for surprise expenses during that repayment period.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy makes more sense if you’re in worse financial straits with a mortgage you can’t afford and when refinancing isn’t an option.

You may be desperate to avoid foreclosure and motivated by an unwillingness to walk away from your equity. Such a sentiment is understandable but not always realistic.

If you have no realistic chance of making ends meet or paying off your big debt balances, a Chapter 7 liquidation bankruptcy can change your life dramatically. 

With Chapter 7, your credit is destroyed in the short term, and you’ll have no access to unsecured debt or mortgages for at least a few years. You’ll also have no home or car because your creditors can seize their collateral. You’ll have to move into an apartment and find some way to buy a car.

The trade-off is that most or all of your unsecured debt will be discharged. You’ll have no property taxes or mortgage insurance to worry about. Chances are that your income will be sufficient to support a modest lifestyle, including rent, food, and even a short vacation occasionally. 

Without those oppressive debt payments, you can start funding a savings account and making retirement plan contributions. You’ll learn how to live on cash, which makes you financially stronger in the long run.

Qualifying for a Mortgage After Bankruptcy

The most critical step to get your credit back on track post-bankruptcy is establishing new credit with a good payment history. Pay all your bills on time every month, and don’t run up debt on your credit cards.

You must take a patient, long-term view of your finances because bankruptcies stay on your credit report for up to ten years, but the damage they cause fades each year.

You won’t be able to apply for a mortgage loan immediately after a Chapter 7 or Chapter 13 bankruptcy. One look at your credit report will doom you to not being approved for the time being.

To apply for a conventional mortgage loan, one not insured by a government agency, you must wait at least four years after the discharge of a Chapter 7 bankruptcy. You’ll have to wait at least two years after the discharge of a Chapter 13 filing.

To apply for a loan insured by the Federal Housing Administration or U.S. Department of Veterans Affairs, you must wait two years after your Chapter 7 bankruptcy is discharged. You can apply after a Chapter 13 filing if you’ve made 12 months of consecutive on-time bankruptcy payments.

You will need approval from the bankruptcy court to apply.

You’ll pay more for the privilege if approved because you’re seen as a higher credit risk.

Re-establishing Credit

Establishing new credit after a bankruptcy is a challenging task. Many credit card companies will hesitate before making credit available to you. One way to start is by applying for a secured credit card.

These cards are easier to get because their credit limits are tied to money you deposit with the bank offering them. If you miss your payments, the bank can simply withdraw the funds from the account you’ve created.

Getting a secured credit card, charging items each month, and paying off your purchases in full by every due date is one way to start rebuilding your credit score.

Start Saving for a Down Payment 

While you’re waiting to apply for a mortgage, save as much as possible for a down payment. If you can save up at least 20% of your home’s final purchase price for a down payment, you’ll increase the odds of qualifying for a lower interest with your mortgage.

That’s because your lender will see that you’ve invested more of your money upfront in your home purchase, making them more comfortable, especially after a bankruptcy.

Employ time-honored tactics like using automatic deposit from your paycheck into a savings vehicle to help you get into a saving habit.

Review Your Credit Report

Scrutinize your credit report to ensure it’s accurate. If you find any mistakes, work with your creditors to clear up any discrepancies.

You can get free copies from the major credit reporting bureaus, and you should look at each of them initially to see how you can minimize collateral damage to your credit score.

Finding the Right Lender

The financial world is filled with lenders, but only some will refinance or issue a new mortgage after bankruptcy. Many of these are subprime lenders who charge you a higher interest rate and tack on fees to handle your loan.

Scrutinize rates, especially fees, which certain unscrupulous mortgage brokers will gladly pump up at your expense.

An FHA loan is one of the best options to refinance your home after bankruptcy. FHA loans can be approved in as little as two years after bankruptcy and have low equity requirements and attractive interest rates for borrowers with flawed credit.

You don’t even have to currently have an FHA mortgage to refinance into an FHA loan.

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at http://www.lenderinsider.com/blog.

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