How to get a mortgage after bankruptcy
Rebuilding your way back to homeownership
While a bankruptcy does make it harder to move forward with certain financial goals, you don’t have to forgo the dream of homeownership.
“If someone is attempting to get a mortgage after filing bankruptcy, they will need to wait and work on their credit for some time prior to applying,” said Derek Jacques, an attorney at The Mitten Law Firm in Southgate, Michigan.
Jacques said that while a bankruptcy can remain on your credit report for between seven and 10 years, he has seen clients get approved for a home loan just five years after bankruptcy.
“It will, of course, be brought up in the process, but as long as you have worked hard to rebuild post-bankruptcy, then you can definitely attempt to secure a home loan," he said.
- Different types of bankruptcy impact how soon you will be able to apply for a home loan.
- To qualify for a mortgage after bankruptcy, you'll need to demonstrate stable income and employment, as well as repair your credit and provide a detailed letter of explanation.
- Alternative finance options, such as rent-to-own, may be available for those who can't qualify for a traditional mortgage.
How bankruptcy affects getting a mortgage
Depending on the type of bankruptcy you filed for, it will have varying consequences on your credit score and your chance to get a mortgage.
- Chapter 7 bankruptcy can remain on your credit report for up to 10 years. Since this level of bankruptcy erases all eligible debts, your credit score is hit the hardest.
- Chapter 13 bankruptcy is a little gentler on your credit score since you repay some of the debt. It can stay on your credit report for up to seven years.
With either bankruptcy, it can take several years to rebuild your credit, which you can do with a secured credit card or loan or by being an authorized user on someone else’s card.
Since mortgage lenders have credit score minimums, along with debt-to-income (DTI) ratio and down payment requirements, having poor credit is an automatic denial. Even when you boost your credit score to meet lender requirements, underwriting will want to know the reason for your bankruptcy and assess your overall financial stability. You will need to provide a detailed letter of explanation that highlights the circumstances leading to your bankruptcy and demonstrates your efforts to rebuild your financial standing.
Mortgage types and requirements after bankruptcy
The good news is that you don’t have to wait until your bankruptcy has fallen off your credit report to apply for a loan. Most loan types only have a two- to four-year waiting period after bankruptcy.
However, if you had a foreclosure on your record along with your bankruptcy, you might have to wait up to seven years before applying for a mortgage loan.
Conventional loans often require higher credit scores, typically around 620 or higher, and a down payment of at least 3% to 5% of the home's purchase price.
FHA loans have more lenient credit score requirements, typically around 580 or higher, and a down payment requirement of 3.5% of the home's purchase price.
The waiting period for a USDA loan is typically one year after Chapter 13 or three years after Chapter 7 filing.
Expect to wait one year if you filed a Chapter 13 or two years after a Chapter 7.
Applying for a mortgage after bankruptcy: step by step
Expect to have your financials scrutinized more closely during the mortgage process than someone who has not been through bankruptcy. Many lenders are willing to work with you but will need to determine that you are not a financial risk.
Repair your credit
The first and most important step is to repair and rebuild your credit. This step can take over a year, depending on how low your credit score dropped during the bankruptcy process.
Start by reviewing your credit reports from all three major credit bureaus (Experian, Equifax and TransUnion) to identify any errors or inaccuracies.
You will also need to get your credit score above the lender’s minimum requirements (about 620) by making regular on-time payments on a secured card or loan and keeping your debt load minimal.
Keep steady employment
Your employment history and income are a great way to show lenders that you are financially stable. Now is not the time to switch jobs. If possible, make the switch after your mortgage loan is secured.
Your lender will want to see your pay stubs, tax returns and employment verification for the loan application process.
Save for your down payment
While most loans will require a down payment of between 3% and 5%, a larger down payment can also show the lender your serious financial commitment. In some cases, a larger down payment might help you secure a better interest rate.
However, if you can’t save up more than 5% for your down payment, don’t let it stop you from applying for a home loan.
Build a reserves fund
A mortgage reserves fund can be made up of cash savings or eligible investments, such as vested funds in a retirement account or stocks, bonds or certificates of deposit (CDs).
Your reserves fund shows the lender that you can cover a certain number of mortgage payments if an emergency were to happen.
Write a detailed letter of explanation
Be prepared to write a letter of explanation when you apply for your mortgage. This will be a letter that outlines the circumstances that led to your bankruptcy and the steps you have taken to ensure you are financially stable now.
Work with a bankruptcy-experienced mortgage professional
When researching loan officers and mortgage brokers, look for ones that have helped post-bankruptcy clients secure homes. Mortgage professionals who are well-versed in post-bankruptcy homebuying will understand the specific requirements and can advise on what you need to do to improve your mortgage approval chances.
Alternate finance options for post-bankruptcy homebuying
If you are unable to qualify for a traditional mortgage after bankruptcy, there are other finance options. Here are a few alternatives to consider:
- Rent-to-own: Rent-to-own agreements work well for those with lower credit scores or higher levels of debt. The process allows you to rent a property with the option to buy it at a later date. A portion of your monthly rent payments goes toward building equity in the property, providing an opportunity to become a homeowner over time.
- Owner financing: In an owner financing arrangement, the property seller acts as the lender and provides financing directly to the buyer. This option eliminates the need for traditional mortgage lenders and may be more accommodating for individuals with a bankruptcy history. The terms of the financing, including the down payment, interest rate and repayment period, are negotiated between the buyer and the seller.
- Housing programs: A government-sponsored housing program might be available in your area for potential buyers who are struggling to meet eligibility criteria.
Can I use a co-signer to improve my chances of getting a mortgage after bankruptcy?
A co-signer with an excellent credit score and low DTI can help increase your chances of being approved for a mortgage loan, along with securing a better interest rate. While using a co-signer is beneficial for you, it is extremely risky for the other person since they will be equally responsible for the loan.
Can I buy a house if my spouse files bankruptcy?
The answer depends on your unique situation. If your spouse filed for bankruptcy and it did not affect your credit score or report, then you should be clear to move forward with a mortgage loan. However, if you were hoping to put your spouse on the loan or use their income to qualify, lenders will impose stricter eligibility requirements.
How long after Chapter 7 bankruptcy can I apply for a mortgage?
Chapter 7 bankruptcies stay on your credit report for a longer period of time than Chapter 13. Similarly, you will need to wait longer to apply for certain mortgages. Expect to wait two years for a VA or FHA loan, three years for a USDA loan, and up to four years for a conventional loan.
Bankruptcy can have a huge impact on your finances, but it doesn't mean homeownership is an impossible goal. If you can fix your credit and build up enough savings for a down payment and mortgage reserves fund, you can increase your eligibility for a home.
If the waiting period is too long for the type of mortgage you want, alternative homebuying options, like rent-to-own or owner financing, are also available.
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