There are multiple financing options available to buyers post-bankruptcy. The most important step is to make the most of your waiting period before you apply for a loan.
Written by Kristin Turner, Harvard Law Grad.
Updated April 19, 2022
For many people, owning a home is part of the American Dream. Some people are afraid that filing a Chapter 7 bankruptcy will end that dream. The good news is that it’s possible to buy a house after bankruptcy.
If you’re considering bankruptcy, your credit score is probably already too low to buy a house anyway. Bankruptcy allows you to wipe the slate clean and rebuild your credit history.
It also looks better on a credit history than having multiple accounts charged off or in collections. Filing bankruptcy shows lenders that you took action to get your finances under control.
Your ability to buy a home after bankruptcy may impact your decision of whether to file. Though individual situations vary, millions of people with bankruptcies on their records successfully apply for home loans. This article can help prepare you for what to expect when buying a home after bankruptcy.
What if I Previously Owned a Home?
In many cases, people file for bankruptcy after they’ve owned a home at some point. If that’s the case for you, you may have experienced one of the following events foreclosure, short sale, or a deed in lieu of foreclosure. These pre-bankruptcy events can have different impacts on your credit report. All of them are usually included and then erased in bankruptcy.
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The following guidelines are accurate as of 2018. They are subject to change from time to time, so it’s important to get the latest information.
The two most important things to consider when shopping for a post-bankruptcy loan are the interest rates and the required waiting period between your discharge and the time you apply for the loan.
Most homebuyers with credit scores in the mid-600s usually opt for government-backed mortgage loans with the Federal Housing Administration (FHA) or Veterans Administration (VA). In some cases, you don’t need to be a veteran to receive a VA loan.
Federal Housing Administration (FHA) Loans vs. VA Loans
Here are some of the ways FHA loans and VA loans differ.
Federal Housing Administration Loans
Interest Rates. FHA loans usually have slightly lower interest rates than VA loans. Every little bit counts. When considering a 30-year or 40-year loan, a few tenths of a percentage point is a lot of money.
Waiting Period. If you file Chapter 7 bankruptcy, you may qualify for an FHA loan two years after your bankruptcy is discharged if your credit score is at least 640. That’s shorter than the foreclosure, short sale, or deed in lieu of foreclosure waiting period, which is three years.
Veterans Administration (VA) Loans
Interest Rates. VA loans usually have higher interest rates. But many VA loans require little or no down payment.
Waiting Period. The bankruptcy waiting period is also two years for VA loans. That’s the same waiting period as foreclosure and other derogatory events. The VA’s minimum credit score (620) is a little lower than the FHA minimum.
Conventional Loans. If you’re willing to wait for four years, you may qualify for a conventional loan. Four years is Fannie Mae’s minimum waiting period, and most other lenders follow Fannie Mae’s guidelines.
How To Maximize Your Waiting Period
Most loans have a minimum waiting period before you can borrow again after bankruptcy. You can take steps to make the most of your waiting period. This can put you in the best position possible when the wait is over.
Build Up Your Savings: Down Payments and Mortgage Insurance
Building up your savings is always a good first step. It will give you more flexibility later on whether you decide to buy a house or not. If you do buy a house, you’ll need a down payment.
The more you put down, the better off you’ll be. Paying more upfront can help you decrease your monthly mortgage payments and decrease the lender’s risk when you borrow.
A Note About Pre-Bankruptcy Savings
As a side note, if you’ve already begun saving for a down payment, filing bankruptcy may still be an option. Many states have a wild card exemption which protects savings accounts and other non-exempt assets. If that’s not the case in your state, you might want to talk to an attorney about how to protect your plans to buy a home.
The waiting period also gives you a chance to practice financial discipline. As a homeowner, you’ll be responsible for all repairs and maintenance. So, in addition to the monthly payment, you’ll need a reserve to handle things like lawn care, air conditioner breakdowns, water leaks, and anything else that might come up.
Use the months between your bankruptcy discharge and applying for a home loan to track your money and practice using a budget. Act as if you’re already making your mortgage payment, and put away a little money each month for unexpected expenses. Use these few months to get in the swing of things so that you can transition to your new home and lifestyle smoothly.
Improve Your Credit Score
Pay all your bills on time. A consistent, on-time payment record is the best way to build your credit score and credit history. That’s especially true for auto loans, credit card bills, and other accounts that lenders report to credit bureaus.
Get a secured credit card. A credit card is actually a great way to rebuild your financial profile. It may sound strange since you just discharged your debt. But, showing off good and consistent credit habits will make you a more attractive borrower. Charge something every month, and make more than the minimum payment on time every month.
Work With Lenders
Mortgage lenders have written rules for dealing with people who have prior bankruptcies. But in most other cases, like auto lenders, the rules are either unwritten or more like guidelines instead than commandments. Being straightforward about your history will help you get your best outcome.
Focus on your current financial track record. Most lenders only care about a person’s recent financial history. Unless there’s a written rule to the contrary, if it happened more than about six months ago, it’s probably not a big deal. So it’s very important to pay bills on time and work to rebuild your score.
Be upfront about your financial past. Before the lender runs your credit report, tell your story. Your fresh start is the latest chapter in a much larger story. You’re meeting with a lender to talk about what comes next. At worst, the lender will refuse to loan you money. If that’s the case, just go somewhere else. There are plenty of other lenders out there that will work with people with a history of bankruptcy. You just have to find the right one.
Bankruptcy may delay your goal of homeownership. But in the end, it will make this goal easier to reach. A few years after you receive your fresh start, your finances will probably look completely different. And that’s what mortgage lenders want to see. Once the required waiting period has passed, there are multiple financing options available to buyers after bankruptcy. It’s important to make the most of your waiting period by budgeting, saving, and rebuilding your credit score.