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 August 11, 2020
For many people, home ownership is still the American Dream. Some of these people are afraid that a Chapter 7 bankruptcy may end that dream. The good news is: it is possible to buy a house after bankruptcy.
If you are considering bankruptcy, your credit score is probably already too low to buy a house anyway. Bankruptcy offers an opportunity to wipe the slate clean and rebuild your credit history.
Additionally, bankruptcy looks better on a credit history than multiple charge-offs and collections referrals. Instead of doing nothing, these tell lenders that you took action.
Your ability to buy a home after bankruptcy may impact your decision of whether or not to file. Although, sometimes the details of your specific situation can influence what your options are post-bankruptcy, 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, but all usually get included, and then erased, under the bankruptcy.
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 or Veterans Administration. In some cases, you do not need to be a veteran to receive a VA loan. Below are some of the differences to consider:
Federal Housing Administration (FHA) Loans.
Interest Rates. FHA loans usually have slightly lower interest rates than VA loans. Every little bit counts. When considering a 30 or 40-year loan, a few tenths of a percentage point is a lot of money.
Waiting Period. People who file Chapter 7 bankruptcy might qualify for FHA loans two years after the bankruptcy was discharged, provided that their 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. That’s because bankruptcy is more of a take-control financial move.
Veterans Administration (VA) Loans.
Interest Rates. VA loans usually have higher interest rates. However, 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 minimum waiting period before you can borrow again. Nonetheless, there are still steps you can take 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, you’ll need the down payment.
When it comes to buying a house: the more you put down, the better off you’ll be. Paying more up front can help you decrease your monthly mortgage payments and decrease the lender’s risk when you borrow.
As a side note, if you have already begun saving for a down payment, filing bankruptcy may still be an option. Many states have generous wild card exemptions which protect savings accounts and other nonexempt 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 give you a chance to practice financial discipline. As a homeowner, you’ll also be responsible for all repairs and maintenance. And, if you move into an older home, a home warranty might be a good idea.
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 discharge and loan application to track your money and practice using a budget. Act as if you are already making your mortgage payment, and put away a little money each month for unexpected expenses. Using 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
Improving your credit will take some time, but fortunately you can catch your stride immediately, There are straightforward ways to get back on track.
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.
Higher limits look better on your report, and a relatively low limit is easier to qualify for. 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 of 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. If it happened more than about six months ago, unless there is a written rule to the contrary, it’s probably not a big deal. So, it’s very important to pay bills on time and affirmatively 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. Bankruptcy is so common that your lender knows many people who have bounced back. 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 who will work with people with a history of bankruptcy. You just have to find the right one.
Bankruptcy may delay, your goal of home ownership. But, in the end, bankruptcy also makes 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 your have waited the required amount of time, there are multiple financing options available to buyers post-bankruptcy. The most important steps are doing all that you can to make the most of your waiting period.