If you have had a bankruptcy within the past few years, you may still be able to qualify for a mortgage. But since bankruptcy is considered to be a major derogatory credit event, there are certain limits. Knowing those limits is the key to getting your loan application approved.
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Mortgage Rules on Bankruptcy
Bankruptcy rules are a little bit different for conventional mortgages and FHA mortgages. Generally speaking, FHA is more lenient.
Here are the rules on bankruptcy for the two loan types:
There are two types of personal bankruptcy, Chapter 7 and Chapter 13. The rules are based on which type you’ve filed.
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Chapter 7. This is a complete bankruptcy, in which your debts are discharged almost immediately. No repayment of debt is imposed by the court. For this type of bankruptcy filing, conventional loans require that at least four years have passed since the date of discharge of the bankruptcy.
Chapter 13. Under this type of bankruptcy, you enter into a debt repayment plan through the court. The term of the repayment can be as long as five years. For this type of bankruptcy, conventional financing requires that a minimum of two years have passed since the bankruptcy discharge date.
Please note that in either type of bankruptcy, the clock doesn’t start running until the bankruptcy is discharged. In the case of Chapter 13, that could mean that the entire waiting process takes up to seven years – the five-year debt repayment term, plus the two-year wait.
FHA also has separate rules for Chapter 7 and Chapter 13.
Chapter 7. The rule on this type of bankruptcy is two years from the date of discharge. It’s also important to understand that while that is the minimum guideline by FHA, many lenders may have additional requirements.
Chapter 13. FHA will permit a mortgage while you are still in the repayment term. But a minimum of one year of payments is required, and those payments must be made on time. Also, your application for a mortgage will require approval by the bankruptcy court, which will not be automatic.
General Credit Requirements
Getting approved for a mortgage with a bankruptcy in your past isn’t something that will necessarily happen just because you meet the minimum requirements specific to bankruptcy.
Because of the bankruptcy, the lender will pay very close attention to your current credit situation.
Credit Score. Apart from specific bankruptcy guidelines, you must also meet minimum credit score requirements. For conventional mortgages, that means a minimum score of 620. For FHA loans, you need a minimum of 580 on a purchase and at least 500 for refinance.
Your credit score may not be that high just one or two years out of bankruptcy. That’s a major reason why people must often wait beyond the minimum time requirement to purchase a home.
Credit History. Even if you meet the minimum credit score requirements, your application could still be declined if you have any major derogatory events, like a large collection or judgment, or a pattern of late payments.
Rent History. Lenders will typically look to verify your rent history, even if you don’t have a bankruptcy. But if you do, they will look very closely to make sure that you can manage your current rent payment comfortably.
Though they may get a rent verification from your current or previous landlord, it’s likely that they will also ask you to provide copies of canceled rent checks for at least the past 12 months. You should be ready to provide 24 months, since an anxious lender may require it.
If you show any late payments within the past 12 months, the lender may determine that you are not yet ready for homeownership.
Other Lending Requirements
Any time you apply for a mortgage the lender will also be concerned with your employment, income, and debt ratios.
With employment, they will be looking for stability, at least since the bankruptcy. That means that you will have to have been the same job, or a similar job, for at least the past two years. If you’ve shown advancement, that’s even better.
Your income must be sufficient to carry the mortgage and your current debts. On FHA mortgages, the debt-to-income ratio (DTI) is limited to 41%. On conventional mortgages, it’s no more than 36%. Lenders often exceed these limits if your overall financial position is strong. But if you have a bankruptcy in your past, those limits are unlikely to be exceeded.
Getting Yourself Ready to Apply for a Mortgage After Bankruptcy
If you have a bankruptcy in your past, the best strategy is to make sure that you are well above the minimum requirements. The stronger your overall profile is, the less important the bankruptcy will be.
On the credit side, you should make sure that all of your payments since the bankruptcy have been made on time. It will also help if you can reestablish credit. Even having just a couple of new accounts since the bankruptcy can be a major help since it will add good credit to your profile.
You can often re-establish credit with secured credit cards or installment loans. Check with a local bank or credit union and set up a “credit builder loan.” Those are loans in which you borrow a certain amount of money that’s deposited into a savings account. The savings account serves as security for the loan, and can even be the source of the monthly repayments.
These loans are routinely made to people with impaired credit history. And since the lenders report your payment history to the credit bureaus, it’s an outstanding way to improve your credit score.
You should also be sure that your debt ratio comes in well below the maximum for each loan program. For example, if your DTI is 30%, and you apply for a conventional mortgage, you will be well below the maximum level.
It will also help if you can make more than a minimum down payment. For example, while conventional mortgages require a minimum down payment of 3%, making a downpayment of 10% or certainly 20% would help your cause considerably.
Applying for a mortgage with a bankruptcy is certainly doable. But you have to be fully prepared to demonstrate that you have “cleaned up your act,” and that the events that led to your bankruptcy filing aren’t likely to be repeated.