Many people are concerned that filing bankruptcy will prevent them from buying a house in the future. The truth is, filing bankruptcy doesn’t prevent you from buying a house.
Written by Attorney John Coble.
Updated December 28, 2020
Many people are concerned that filing bankruptcy will prevent them from buying a house in the future. The truth is, filing bankruptcy doesn’t prevent you from buying a house. A bankruptcy filing can be your first step toward home-ownership. Many real estate agents and mortgage brokers have relationships with bankruptcy attorneys. In some cases, you don’t even have to wait until your bankruptcy is over before buying a home.
The factors that determine how soon you can buy a house after filing bankruptcy include which type of bankruptcy you choose, the particular lender, and your credit report. Before going further, here is a brief description of the two types of consumer bankruptcies available for you.
Chapter 7 Bankruptcy
In a Chapter 7 bankruptcy, the bankruptcy trustee sells any nonexempt assets to pay your unsecured debts. The key term here is “nonexempt assets.” It’s rare for a Chapter 7 bankruptcy filer to have any property that falls in this category. So, the filer loses nothing to the bankruptcy trustee. A secured creditor can take the collateral securing their loan in a Chapter 7 bankruptcy. An example of such a secured creditor would be a car loan company where the collateral is the car. Losing assets you wish to keep to a secured creditor in a Chapter 7 bankruptcy is also rare. Most people that file a Chapter 7 bankruptcy lose nothing but their obligation to pay the discharged debt.
Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, your bankruptcy attorney creates a repayment plan that consolidates your debts. This Chapter 13 plan modifies your secured debts and only pays a portion of your unsecured debts to create a three-year or five-year repayment plan that is affordable for you. At the end of your Chapter 13 plan, the court enters your discharge and you’re debt-free.
Since the bankruptcy court oversees your Chapter 13 plan, any new loans you take out during your Chapter 13 plan require court approval. The bankruptcy court will approve a new home loan if it makes financial sense for you to take on this new debt. A Chapter 13 bankruptcy may be your best choice if you have enough income to fund a plan and your primary goal is to buy a home as soon as possible.
Government guaranteed mortgages such as FHA loans, VA loans, and USDA loans are the quickest way to buy a home if you’ve recently filed bankruptcy. Conventional loans do take a little longer. Both types of mortgage loans do have a waiting period before you can buy a home after filing bankruptcy. The lenders will check your credit report and see when you filed for bankruptcy.
Government Guaranteed Mortgages
With a FHA loan, the Federal Housing Administration (FHA) insures a loan for your home purchase. If you default on one of these loans, the federal government pays the mortgage lender. Even so, when you default on your mortgage, your house is subject to foreclosure since the FHA is going to minimize its loss.
The FHA has rules for firms that lend FHA backed loans. The FHA will not allow a loan for anyone that has a Chapter 7 bankruptcy discharge within the last two years. Some lending firms that create FHA backed loans may have more stringent rules than this.
With a Chapter 13 bankruptcy, approval for an FHA mortgage can occur before your discharge date. You only need to make one year of on-time monthly payments to the trustee before you can apply for an FHA loan. Still, you need to jump through two hoops. First, the lender making the FHA loan will have to be willing to make the loan. Second, the bankruptcy court will have to approve taking out new debt to buy a home. Courts approve such mortgages when the court sees that it will put you in a better financial situation. One factor the Court will consider is the amount of the monthly mortgage payment compared to your current rent payment.
VA loans are a choice for eligible military veterans. In some cases, the spouse of a deceased veteran whose death was service-related is eligible. The Department of Veterans Affairs (VA) guarantees these loans. VA loans have the same bankruptcy wait periods as FHA loans. That is, you must wait two years after a Chapter 7 discharge or one year after the filing date in a Chapter 13 bankruptcy.
The United States Department of Agriculture’s Rural Development program guarantees USDA loans. USDA loans are available for lower-income applicants in qualifying rural areas. The waiting period after bankruptcy for approval of these loans is a little different from FHA loans and VA loans. Except in cases of extenuating circumstances, the waiting period is three years after the discharge in a Chapter 7 bankruptcy and one year after the discharge in a Chapter 13 bankruptcy.
If there are extenuating circumstances, the waiting periods can be as low as one year after a Chapter 7 discharge and one year of on-time payments in a Chapter 13 plan. Your extenuating circumstances must have occurred within the twelve months before filing bankruptcy. An extenuating circumstance could be a temporary job loss or illness. The job loss or illness needs to be the cause of the financial distress that led to your bankruptcy. Another example of an extenuating circumstance is that the proposed loan will reduce your monthly housing cost by 50%.
Besides these federal government programs, many state and local governments, as well as nonprofits, have programs to assist people with buying a home.
The great majority of conventional loans in America are grouped into mortgage pools. These pools issue bonds and sell them to private investors. The three organizations that pool the mortgages and issue these bonds are Ginnie Mae, Fannie Mae, and Freddie Mac. Ginnie Mae is wholly government-owned and only underwrites government-guaranteed mortgages such as FHA, VA, and USDA loans. Minimum eligibility requirements for these loans depend on the government agency guaranteeing the loan.
Fannie Mae and Freddie Mac were both created by an act of Congress, but are private companies and aren’t government-owned. Fannie Mae and Freddie Mac underwrite private loans and some government-insured loans. For this reason, Fannie Mae and Freddie Mac have their own minimum requirements for making loans. Freddie Mac and Fannie Mae often require private mortgage insurance to protect it from default with conventional loans just as government guarantees protect the lender for FHA, VA, and USDA loans. The private lenders that sell these loans to Fannie Mae or Freddie Mac may have more stringent requirements.
Fannie Mae and Freddie Mac
Fannie Mae does not permit lenders to issue mortgages to applicants that have had a Chapter 7 discharge within the last four years. In cases with extenuating circumstances, the waiting period in a Chapter 7 can be as short as two years after discharge. For a Chapter 13 bankruptcy, the waiting period is two years after discharge or four years after dismissal. An exception to the four-year waiting period for dismissed Chapter 13 cases is a two-year period in cases with extenuating circumstances. Fannie Mae considers divorce, large medical bills, and job loss to be “extenuating circumstances.” Freddie Mac has the same requirements as Fannie Mae. Freddie Mac defines “extenuating circumstances” as an event that was beyond the borrower’s control.
Some conventional loans are still made by banks and not sold to Fannie Mae, Freddie Mac, or Ginnie Mae. For these loans, the bank has complete discretion over the loan terms. If your brother is the loan officer, you may get a loan right after a Chapter 7 discharge. For most people, these loans will be harder to get after filing bankruptcy.
The bankruptcy waiting period required by the different agencies may not be the most important consideration. The most important factor could be your credit score. This is why taking the proper steps to rebuild your credit after bankruptcy is so important. Your credit report will determine the interest rate you pay as well as the amount of your down-payment. The credit score requirements depend on the type of loan. For FHA backed mortgages, you need a minimum credit score of 500. The FHA requires a smaller down-payment if your credit score is 580 or above. There is no minimum credit score for VA Loans. The VA allows lenders to consider other factors beyond mere credit scores. Still, the lenders making the VA backed loan have discretion, so a common credit score for approved loans is usually around 620.
The USDA streamlines the application process for those with a credit score of 640 or above. If your credit score is below 640, the USDA requires its lenders to take a closer look at your credit history to determine if you’re an acceptable credit risk. Wit Fannie Mae, the minimum credit score is 620. Under certain circumstances, such as an adjustable-rate mortgage instead of a fixed-rate mortgage, the minimum credit score is 640. For Freddie Mac, the minimum credit score is 620. As with Fannie Mae, certain circumstances will increase the minimum credit score to 640 or above.
As you can see, bankruptcy doesn’t prevent you from buying a home. Since the debt relief provided by bankruptcy can speed up the rebuilding of your credit, bankruptcy can quicken your ability to be able to buy a house. How bankruptcy will affect you depends on your particular circumstances. Often, a Chapter 7 bankruptcy will be your best choice. In some cases, a Chapter 13 bankruptcy will be better. In some Chapter 7 cases, you may qualify to file your own free bankruptcy using Upsolve’s online tool. In other cases, you may need to see an attorney for a free initial consultation and it may make sense to hire a lawyer if you can afford to. It’s a good idea to learn everything you can about bankruptcy by looking at Upsolve’s Learning Center. Regardless of the method you use, Upsolve would like to see you in your new home.
- American Bankruptcy Institute. (2002). Bankruptcy by the Numbers - Chapter 7 Asset Cases. ABI Journal. Retrieved August 4, 2020, from https://www.abi.org/abi-journal/chapter-7-asset-cases
- U.S. Department of Veterans Affairs. (n.d.). Eligibility requirements for VA home loan programs. Retrieved August 10, 2020, from https://www.va.gov/housing-assistance/home-loans/eligibility/
- Consumer Financial Protection Bureau . (n.d.). Special Loan Programs. Loan Options. Retrieved August 10, 2020, from https://www.consumerfinance.gov/owning-a-home/loan-options/special-loan-programs/
- Fannie Mae. (2019, August). B3-5.3-07, Significant Derogatory Credit Events - Waiting Periods and Re-establishing Credit. Selling Guide. Retrieved August 10, 2020, from https://tinyurl.com/y2x22tpk
- Fannie Mae. (2014, December). B3-5.3-08, Extenuating Circumstances for Derogatory Credit. Selling Guide. Retrieved August 10, 2020, from https://tinyurl.com/y35uupsn
- Freddie Mac. (n.d.). Credit Assessment for Manually Underwritten Mortgages. Single-Family Seller/Servicer Guide. Retrieved August 10, 2020, from https://guide.freddiemac.com/app/guide/section/5202.5
- HUD. (2010, September). Minimum Credit Scores and Loan-to-Value Ratios. Retrieved August 10, 2020, from https://www.hud.gov/sites/documents/10-29ML.PDF
- U.S. Department of Veterans Affairs. (2018, October). VA Guaranteed Loan. Retrieved August 10, 2020, from https://www.benefits.va.gov/BENEFITS/factsheets/homeloans/VA_Guaranteed_Home_Loans.pdf
- U.S. Department of Agriculture. (2018, March). Section 502 Direct Loan Program’s Credit Requirements. Rural Development. Retrieved August 10, 2020, from https://www.rd.usda.gov/files/RD-SFH-CreditRequirements.pdf
- Fannie Mae. (2020, August). B3-5.1-01, General Requirements for Credit Scores. Selling Guide. Retrieved August 10, 2020, from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-1-Credit-Scores/1032996841/B3-5-1-01-General-Requirements-for-Credit-Scores-08-05-2020.htm
- Freddie Mac. (2019, December). Single-Family Seller/Servicer Guide. Bulletin 2019-25. Retrieved August 10, 2020, from https://guide.freddiemac.com/ci/okcsFattach/get/1001720_5/