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Getting a Mortgage After Bankruptcy

FHA Back to Work Program

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The FHA Back To Work program is a mortgage loan program available via the FHA which reduces the waiting period to purchase a home after bankruptcy, foreclosure, or short sale. To qualify for the program, mortgage borrowers must (1) meet standard FHA loan requirements, (2) document prior financial hardship, (3) re-establish a responsible credit history, and (4) attend a brief homeowner counseling program.

Editor's Note: FHA discontinued its Back to Work program as of September 30, 2016. This post will not be deleted for archival purposes.

The following guidelines are now in effect:

Getting a mortgage after bankruptcy can be a challenge, but it’s not impossible. Many lenders have established guidelines for underwriting home loans for borrowers who’ve emerged from bankruptcy, completed a waiting period, and otherwise met certain eligibility requirements.

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This guide will discuss how bankruptcy impacts your ability to get a mortgage, loan programs available, and tips for getting approved.

Part I: How Bankruptcy Impacts Your Ability to Get a Mortgage

Whichever bankruptcy chapter applies, the bankruptcy will stay on your credit report for seven to 10 years. How much it affects your credit score depends on your entire credit profile. For instance, someone with a good credit score may see a significant drop in their score. According to myFICO, someone with a score in the mid-700s might see their score drop by 100 points or more.

On the other hand, someone who already has a poor credit score may not see a dramatic difference.

Although the bankruptcy will remain on your credit report for up to 10 years, its impact will lessen over time.

Before we dig into the details of qualifying for a mortgage after bankruptcy, let’s review the types of bankruptcies and the differences between each.

Chapter 7: Liquidation

This is the most common form of bankruptcy for individuals. When you file Chapter 7 bankruptcy, you will have to liquidate many of your assets (some exemptions apply) and then use the proceeds to pay your creditors. Chapter 7 essentially allows you to make a fresh start by releasing you from all dischargeable debts. This type of bankruptcy filing is typically used by people who have no hope of repaying their debts.

Jason Kaplan, the owner of Mortgage Lending Associates in Bluffton, S.C., says anyone can get a mortgage after Chapter 7 bankruptcy, it’s only a matter of how much you put down and how long it’s been since the bankruptcy was discharged.

“If someone has 35 percent to put down on a home, they can apply for a mortgage the day after receiving their bankruptcy discharge, but the interest rates will be high,” Kaplan says. “If a borrower waits one year after discharge, they need 25 percent down with high interest rates. At two years, 20 percent down with high rates.”

After two years, it’s possible to qualify for an FHA loan with only 3.5 percent down, as long as you meet other requirements (explained in more detail below).

Chapter 11: Reorganization

Chapter 11 bankruptcy applies to businesses that wish to continue operations while repaying creditors through a court-approved reorganization plan. It gives the debtor a number of options for returning the business to profitability, including reducing debts by repaying some and discharging others, discharging onerous contracts and leases, and rescaling operations of the business. Upon completion of the plan, the business emerges with a reduced debt load and a reorganized, more profitable business.

Although Chapter 11 bankruptcy applies to business, depending on the business’s legal status and whether the owner took out credit in his or her own name.

Chapter 13: Adjustment of debts

Chapter 13 is designed for individuals who have a regular source of income and a desire to pay their debts but are currently unable to do so. Chapter 13 bankruptcy usually allows the debtor to keep a valuable asset, such as their own home.

In a Chapter 13 filing, the debtor proposes to the court a plan for repaying creditors. The timeline of repayment is typically three to five years. If the court approves the plan, the debtor makes payments to creditors through a trustee. As long as the plan is in effect, the debtor is protected from actions by creditors, including lawsuits and wage garnishments. Upon completion of the plan, any remaining eligible debts are discharged.

 

Waiting Period After Bankruptcy
Type of mortgage Chapter 7 Chapter 11 Chapter 13
Conventional 4 years 4 years 2 years from discharge date, or 4 years from dismissal date
FHA 2 years N/A 1 year
VA 2 years N/A 1 year
USDA 3 years N/A  1 year

 

When does the clock start ticking?

Waiting periods begin once the bankruptcy is discharged or dismissed. For Chapter 7 and Chapter 11, the waiting period is measured from the discharge or dismissal date of the bankruptcy action.

For Chapter 13, the waiting period makes a distinction between bankruptcies that were discharges and those that were dismissed. The shorter waiting period based on the discharge date takes into account that borrowers working toward successful completion of a Chapter 13 bankruptcy have already spent some time working toward paying down debts and getting on better financial footing. Borrowers who were unable to complete their Chapter 13 plan and received a dismissal are held to a longer waiting period.

Although you do not have to wait for the bankruptcy to fall off of your credit report to get approved for a mortgage, it’s a good idea to ensure that it is removed from your credit report as soon as you are eligible so you can start enjoying the benefits of a good credit score.

Chapter 7 and Chapter 11 bankruptcies are removed 10 years from the filing date of the bankruptcy. Chapter 13 bankruptcies are removed seven years from the filing date. Although the credit reporting agencies should delete the bankruptcy from your credit report as soon as the seven- or 10-year waiting period is up, it’s a good idea to monitor your credit report to ensure it’s been removed when it ought to be.

Why you might want to wait

Although some borrowers can be eligible for a mortgage in as little as 12 months following a bankruptcy discharge, waiting longer may be a better move.

Filing for bankruptcy has a major impact on your credit score — one that cannot be quickly remedied. Within one to four years of a bankruptcy filing, the impact of the bankruptcy on your credit score will still be significant. You’ll likely only be eligible for a loan with a higher interest rate, and you might have to come up with more money down.

As shown in the illustrations below, increasing the interest rate by a single point results in paying tens of thousands of dollars more in interest over the life of a 30-year mortgage.

Rather than applying for a mortgage as soon as your waiting period is up, work on establishing a solid financial track record of on-time payments and responsible use of credit. Save up enough for a 20 percent down payment so you can avoid paying mortgage insurance on top of interest.

This will put you in a better position to qualify for a loan, make you eligible for a lower interest rate, and ensure you’re able to manage the mortgage payments when the time comes.

How can a foreclosure prolong a waiting period?

 Post-forclosure waiting periods
Type of Mortgage Waiting Period After Foreclosure
Conventional 2 or 4 years: If foreclosed property was discharged in bankruptcy
7 years: All other cases
FHA 3 years
VA 2 years
USDA 3 years

 

For some individuals, a home foreclosure might be the catalyst for bankruptcy. In that case, having a foreclosure and a bankruptcy on your credit report can lengthen the waiting period for getting approved for a mortgage.

FHA loans require a three-year waiting period after either a foreclosure or a deed in lieu of foreclosure.

For a conventional loan, the typical waiting period after a foreclosure is seven years. However, Fannie Mae and Freddie Mac have special provisions that apply when the mortgage debt on a foreclosed property was discharged through bankruptcy. In that case, a borrower can be approved for a conventional loan two years after foreclosure, as long as the loan proceeds will be used to purchase the borrower’s principal residence (not an investment property), and the borrower has a down payment of at least 10 percent.

Exceptions for extenuating circumstances

It’s important to note that in many cases, the waiting periods mentioned above may be reduced if your bankruptcy or foreclosure  was due to extenuating circumstances.

Fannie Mae defines extenuating circumstances as “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.”

The types of events that qualify as an extenuating circumstance vary by lender, but may include:

If the borrower’s bankruptcy or foreclosure was the result of extenuating circumstances, the lender will require documentation to support their claim. That documentation may include a copy of a divorce decree, medical bills, notice of job layoff, job severance papers, insurance papers, tax returns, etc. The lender will also request a letter explaining the circumstances that led to the bankruptcy or foreclosure.

The waiting period may be reduced to as little as one year, although lender requirements vary, so it’s a good idea to discuss your circumstances with the loan officer.

Part II: Home Loan Options After Bankruptcy

Once the waiting period has passed, your next step is to find a lender who is willing to work with a borrower who has a bankruptcy on their credit report. Fortunately, this is not as difficult as you might imagine.

Conventional mortgage

A conventional mortgage is a loan that adheres to guidelines set by Fannie Mae and Freddie Mac. Conventional loans may have either a fixed or adjustable rate and a term ranging from 10 to 30 years.

In general, conventional mortgages require a minimum credit score of 620, and a down payment of at least 3 percent.

Getting approved for a conventional loan after a bankruptcy requires meeting the waiting period as outlined in the table above, and demonstrating that you’ve re-established your credit. Re-establishing your credit involves paying your bills on time and keeping balances on revolving credit accounts low.

Conventional mortgage cost comparison

To illustrate the difference between getting a conventional loan before and after bankruptcy, consider a borrower who had a credit score of 740 before declaring bankruptcy. The bankruptcy was caused by a sudden illness, so it qualifies as an extenuating circumstance, and he is applying for a $250,000, 30-year mortgage two years after his Chapter 7 was discharged. At that time, his credit score is 640.

 
  Credit Score APR Monthly Principal & Interest Total Interest Paid
Before: 740 credit score 3.687% $1,149 $163,593
After: 640 credit score 4.508% $1,268 $206,445

In this scenario, getting a mortgage after bankruptcy will cost the borrower an additional $42,852 over the life of the loan because his lower credit score resulted in an interest rate almost a full point higher.

FHA mortgage

An FHA loan is a mortgage insured by the Federal Housing Administration. These loans typically offer more flexible lending requirements than conventional loans. FHA loans are available in 15- or 30-year terms, and rates may be fixed or adjustable.

Borrowers with a credit score of 580 and above can get a home loan with a down payment as low as 3.5 percent. With a credit score between 500 and 579, the borrower will need a down payment of at least 10 percent.

In addition to meeting the waiting requirements outlined above, the FHA requires borrowers with bankruptcies to re-establish good credit or choose not to incur any new debts since the bankruptcy . Kaplan says the FHA also requires applicants to submit with their loan application a full explanation of the circumstances that led to bankruptcy.

FHA mortgage cost comparison

To illustrate the difference between getting an FHA loan before and after bankruptcy, consider a borrower who had a credit score of 680 before declaring bankruptcy. The borrower’s bankruptcy was not caused by an extenuating circumstance. She’s reached the two-year waiting period and is applying for a $250,000, 30-year mortgage with a credit score of 620.

 
  Credit Score APR Monthly Principal & Interest Total Interest Paid
Before: 680 credit score 3.864% $1,174 $172,647
After: 620 credit score 5.054% $1,350 $236,114

 

In this scenario, getting a mortgage after bankruptcy will cost the borrower an additional $63,467 over the life of the loan.

VA mortgage

Many veterans are eligible for loans backed by the U.S. Department of Veterans Affairs (VA). VA loans do not have minimum credit score requirements. Instead, the VA requires their approved lenders to “review the entire loan profile to make a lending decision.” However, individual lenders may set their own minimum credit requirements.

VA-backed loans are available with zero down payment and have 15- or 30-year terms with fixed or adjustable rates.

Because VA loans are focused on helping veterans buy homes, they are traditionally more lenient when it comes to a borrower’s credit history. Borrowers are eligible just one or two years after a bankruptcy discharge. During that time, the borrower should work on rebuilding their credit by paying bills on time and keeping balances on revolving credit accounts low.

VA mortgage cost comparison

To illustrate the difference between getting a VA loan before and after bankruptcy, consider a borrower who had a credit score of 760 before declaring bankruptcy. The borrower’s bankruptcy was caused by an extenuating circumstance, and he’s applying for a $250,000, 30-year mortgage just 12 months after the bankruptcy discharge with a credit score of 640.

 
 Credit Score APR Monthly Principal & Interest Total Interest Paid
Before: 760 credit score 3.465% $1,118 $152,384
After: 640 credit score 4.508% $1,268  206,445

In this scenario, getting a mortgage after bankruptcy will cost the borrower an additional $54,061 over the life of the loan.

USDA mortgage

USDA loans are backed by the U.S. Department of Agriculture (USDA) for borrowers purchasing homes in qualifying rural areas. Borrowers are also subject to income limitations of no more than 115 percent of the median income for the area. Mortgages are fixed-rate only and have terms of 15- or 30-years.

USDA-approved lenders typically require a minimum credit score of 620 to 640, with no significant delinquencies, foreclosures or bankruptcies in the past three years, although that waiting period can be reduced to 12 months if the bankruptcy was due to extenuating circumstances.

To get a USDA loan after bankruptcy, borrowers should work on rebuilding their credit during the waiting period by paying bills on time.

USDA mortgage cost comparison

To illustrate the difference between getting a USDA loan before and after bankruptcy, consider a borrower who had a credit score of 700 before declaring bankruptcy. The borrower’s bankruptcy was caused by an extenuating circumstance, and she is applying for a $250,000, 30-year mortgage just two years after the bankruptcy discharge with a credit score of 620.

 
 Credit Score APR Monthly Principal & Interest Total Interest Paid
Before: 700 credit score 3.687% $1,149 $163,593
After: 620 credit score 5.054% $1,268 $236,114

 

In this scenario, getting a mortgage after bankruptcy will cost the borrower an additional $72,521 over the life of the loan.

Part III: Tips for Getting Approved for a Mortgage After Bankruptcy

Whether your circumstances require a waiting period of seven years or just 12 months, you can and should use that time to rebuild credit and improve your credit score. Not only will this improve your chances of getting approved for a home loan when the time is right, but it will also help ensure that you are financially capable of handling your mortgage when the time comes.

How do I improve my finances after bankruptcy?

There is no quick fix for rebuilding your credit after a bankruptcy. However, your most recent actions have a bigger impact on your credit score than negative events from the past, so the impact of the bankruptcy on your score will diminish with each year that goes by.

Open a new credit card account

Eric Klein, a bankruptcy attorney in Boca Raton, Fla., and president of  , has been helping clients through bankruptcy for over 20 years. He says that after a bankruptcy is discharged, his clients typically receive a flood of credit card applications in their mailbox.

Even if you don’t receive a bunch of offers, secured credit cards are typically easy to get and are excellent ways to rebuild credit. You provide the bank or credit card company with a deposit, which could be $200 or more. The bank keeps your deposit as collateral and gives you a credit limit equal to your deposit. “The key is to apply for and obtain a card from a quality bank,” Klein says. “Stay away from credit card offers with extreme interest rates.”

Once open, the secured card works like any other credit card. You charge expenses to your card, and the bank sends you a statement each month. Your credit limit, balance and payment history are reported to the credit bureau. However, if you don’t make your payments on time, the bank can take your deposit and apply it to the debt.

The key to using a secured card to improve your credit is to use the card regularly, keep your utilization low, and pay your bill in full and on time every month. For example, if you have a secured card with a $200 limit, you could use it to buy $40  of gas or groceries, then pay off the balance in full when the statement arrives. This strategy will keep your credit utilization under 20  percent, a threshold that is often cited as ideal.

Pay bills on time

While credit cards, car loans, mortgages and other debts are what typically come to mind when you think about payments that affect your credit score, other payments can impact your score as well.

Rent payments, utilities, medical bills, library fines, cell phone plans, gym memberships and traffic tickets can all impact your score.

If you’re regularly late on your rent, your landlord can report your delinquent payments to the credit bureaus. Medical bills, utility payments, library fines, traffic tickets, gym memberships and cellphone plans can all be referred to collection agencies, which will lower your credit score. Even if you pay the collection off, it will remain on your credit report for up to seven years.

Apply for credit cautiously

When you apply for credit, potential lenders check your credit report, resulting in a “hard inquiry” on your credit report. Hard inquiries can negatively affect your credit score, although the impact varies from person to person based on your unique credit history.

If you are shopping for a loan, such as a car loan, several inquiries within a 30-day period should not negatively impact your score. Credit-rating agencies expect consumers to shop for rates, so they ignore multiple inquiries for the same type of loan made within a 30-day window.

However, opening several new lines of credit within a short time frame can indicate that you’re having money troubles, and that can cause a greater hit to your score.

Don’t close accounts

Closing credit accounts reduces the amount of credit you have available, which increases your overall >credit utilization rate and leads to a lower credit score. It’s best to keep the account open. You can cut up the card if having it tempts you to overspend.

Monitor your credit

After your bankruptcy and before applying for a mortgage, Klein recommends pulling a copy of your credit report from each of the three credit reporting agencies via annualcreditreport.com. Once you have all three reports, Klein says you should analyze each for inaccurate information.

“When doing your analysis, make sure that all the accounts that were discharged in the bankruptcy are accurately reported as ‘Discharged in Bankruptcy’ as opposed to stating ‘Charge Off’ or any other inaccurate information.”

Any incorrect information should be immediately disputed with the credit reporting agency.

Watch out for credit repair scams

You will likely receive offers from credit repair services offering to repair your credit or have negative information removed from your credit report. In most cases, these are scams. There is no quick fix for a bad credit score, and there is nothing that credit repair services can do to improve your score that you can’t do yourself.

If you need professional help managing debt or paying bills, seek out a legitimate credit counseling agency. The U.S. Department of Justice maintains a list of approved agencies.

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The Federal Housing Administration sponsored “Back to Work – Extenuating Circumstances” program is a mortgage loan counseling program designed to shorten the waiting time to buy a home for a potential borrower following a financial hardship. According to HUD, if you have had a foreclosure, short sale, deed-in-lieu of foreclosure, or have declared bankruptcy you may qualify for a new home loan if you are back to work and can document the extenuating circumstances. The program waives the traditional 3-year waiting period after a foreclosure, short sale, or deed-in-lieu to apply for an FHA loan, eligible participants can buy a home in as little as one year. This program can be used for both first-time home buyers and repeat home buyers. Mortgage rates remain the same as any other FHA loan. There is no premium on your interest rate and no additional fees at closing. The Back to Work Program does not affect your mortgage rate. The program is not limited by loan size. The FHA will insure up to your county’s FHA loan limit.

Minimum Credit scores are required, a score below 500 is not allowed, which is a standard FHA mortgage guideline, but borrowers with no credit score (“thin files”) whatsoever are still eligible. You are also still eligible for the program if you are currently unemployed. The program ends September 30, 2016.


How Do I Qualify for the Back to Work Program?

To qualify, you must previously have experienced an “economic event” such as a pre-foreclosure sale, short sale, deed-in-lieu, foreclosure, Chapter 7 bankruptcy, Chapter 13 bankruptcy, loan modification, or forbearance agreement. Then you must demonstrate that you have fully recovered from that economic event. You also have to agree to complete housing counseling before closing. Lastly, you must be able to show your household income dropped 20 percent or more for a period of at least 6 months, which coincided with the economic event. The 20 percent income loss applies to everyone in the household. If one member of the household lost income as the result of a job less but the household income did not fall by 20 percent or more, the borrower will not be eligible. The 20 percent loss of income can be demonstrated through federal tax returns, W-2s, pay stubs, or unemployment income receipts. To demonstrate that you have had satisfactory credit since your economic event, your lender will review your credit report. All credit accounts will be scrutinized and your lender will check to see if; a) that you have displayed a responsible and trustworthy credit history prior to the economic event; that the bulk of derogatory credit occurred after or during the economic event; and, that you have re-established a consistent 12-month period of perfect payment history on major accounts. It is important to note that revolving accounts may have minor delinquencies. If you are still in Chapter 13 bankruptcy, you must have written permission from the Bankruptcy Court Trustee to enter into the mortgage.