July 26, 2021

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Home buying with Chapter 13 bankruptcy: What are your options?

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Chapter 13
bankruptcy doesn’t ruin your mortgage chances

If you filed for Chapter 13 bankruptcy or were recently discharged, you might wonder whether you can buy a new home or refinance.

The good news is, getting a mortgage is easier after Chapter
13 bankruptcy than Chapter 7.

You might even qualify while you’re still in Chapter
13. Government-backed FHA, VA, and USDA loans let you apply for a mortgage as
early as one year into your repayment plan.

Keep in mind, you need to make those payments on time. And
you still need to meet loan requirements.

But if you meet these guidelines, you should have a good shot
at getting a mortgage during or after Chapter 13.

Check your mortgage eligibility (Feb 5th, 2021)


In this article (Skip to…)


How Chapter 13 bankruptcy
affects your mortgage eligibility

In many cases,
mortgage lenders will say yes to your loan application while you are still working
through a Chapter 13.

Most mortgage
lenders look more favorably on applicants who file Chapter 13 than those who
file for Chapter 7 bankruptcy. That’s because Chapter 13 filers have made an
effort to repay at least some part of their debts.

This
is reflected in the minimum waiting period to get a loan after each type of
bankruptcy:

  • Chapter 7 bankruptcy: 2-3 years after discharge
  • Chapter 13 bankruptcy: 12 months after filing

Of
course, you’ll still have some extra hurdles to clear if you want to buy real
estate while in Chapter 13.

A
lender needs to see you’ve taken meaningful steps to improve your credit and
debt management before it will approve you for a home loan.

The
requirements to buy a house during or after Chapter 13 depend on the type of
mortgage you hope to use.

Government-backed
loans are more lenient about a Chapter 13 on your credit report, whereas
conforming loans (backed by Fannie Mae and Freddie Mac) impose long waiting
periods.

FHA loan with Chapter 13 bankruptcy

To
qualify for an FHA loan during Chapter 13, you need to be at least 12 months
into your repayment plan. And you must have made all those payments on time.

In
addition, the bankruptcy court or bankruptcy attorney needs to give written
permission for you to take out a new mortgage loan.

If
you successfully completed your repayment plan and got a Chapter 13 discharge,
there is no waiting period for an FHA loan. However, your loan will be referred
for manual review by an underwriter unless it’s been two years since the
discharge date. To get an automated, computerized approval, it has to be two
years since the Chapter 13 discharge.

This is an important point because many lenders will not manually approve a loan. They will deny the loan unless it gets an ‘approved’ status from a computerized underwriting system.

So in this way, many lenders will require a waiting period of two years from the discharge date.

Still, an FHA mortgage might be the most attractive type of loan if you’re currently in a Chapter 13 plan or were recently discharged from one.

Benefits of an FHA loan with Chapter 13

FHA loans have easier credit requirements than other mortgage programs.

The Federal Housing Administration, which insures these loans, only required a 580 credit score and 3.5% down payment.

You might even get away with a credit score of 500-579 if you can put 10% down. (But you’ll have a harder time finding a willing lender.)

Other requirements you’ll need to meet for an FHA
mortgage include:

  • Your debt-to-income ratio (DTI) is below 50%
  • You’re purchasing the home as a primary residence
  • The loan is within current FHA loan limits
  • You have steady employment and income

Most mortgage lenders are approved to do FHA loans, so
you can shop around for a good deal.

If one lender doesn’t approve you because of your
Chapter 13, but you’re past the 12-month mark and meet loan requirements, try
again with a different mortgage company. You might have more luck.

Verify your FHA loan eligibility (Feb 5th, 2021)

VA and USDA loans with Chapter 13 bankruptcy

Like
FHA loans, VA and USDA loans are backed by the federal government. And they
have similar rules about qualifying with Chapter 13.

  • You must be at least 12 months into your repayment plan, with
    on-time monthly payments
  • You need written approval from the court or bankruptcy attorney to
    apply for the loan
  • You need to meet loan program guidelines

If
you completed your full Chapter 13 plan and the court has discharged you, there
are no special criteria to apply for a VA or USDA loan.

Both these loan programs have similar benefits. No down payment is required, and mortgage rates tend to be very low.

To qualify for a VA loan, you must be an eligible veteran, service member, or surviving spouse.

The
Department of Veterans Affairs technically does not set a minimum credit score
for these loans. But most lenders require a FICO score of at least 580-620.

USDA loans are meant for low- to moderate-income home buyers in qualified rural areas.

These loans are very affordable, but a bit harder to qualify for. You’ll need a FICO score of at least 640 for a USDA loan. Borrowers in Chapter 13 might have more luck with an FHA mortgage. 

Check your zero-down loan eligibility (Feb 5th, 2021)

Conforming loan with Chapter 13 bankruptcy

It’s
much tougher to get a conforming loan after Chapter 13 bankruptcy.

Fannie
Mae and Freddie Mac — the two agencies that set conforming loan rules — are
stricter than the government agencies. They will not allow borrowers to apply
while working through a Chapter 13 plan.

Your
bankruptcy must be either discharged or dismissed to qualify for a conventional
mortgage. And there’s a waiting period:

  • Two years after Chapter 13 discharge date
  • Four years after Chapter 13 dismissal date

Remember,
discharge happens after you complete the 3- or 5-year repayment plan.

So
altogether it could take up to 7 years after filing for Chapter 13 before you
can get a conventional loan. (5 years until discharge plus the 2-year waiting
period.)

Filers who fail to complete the
plan may have their bankruptcy “dismissed.” They probably still owe their
creditors and will have to wait at least 4 years from
the dismissal date before they can apply for
conventional financing.

Filers with multiple
bankruptcies in the past seven years will
have to wait at least seven years from their most recent discharge
before applying.

Extenuating circumstances

It
may be easier to buy a house after Chapter 13 discharge if your bankruptcy was
caused by “extenuating circumstances.”

Extenuating circumstances are typically one-time events outside your control that have a serious negative impact on your finances.

Examples include a severe illness or disability, a company layoff, or the death of the primary wage-earner.

If your Chapter 13 falls into this category, the waiting
period for a conventional loan drops to 2 years after dismissal. (The waiting
period after discharge stays the same, at 2 years.)

Freddie Mac offers a clear test
for determining if a bankruptcy has extenuating circumstances:

  • Were the events beyond your control?
  • Has the problem been resolved?
  • Is the problem likely to happen again?

Understand that these tests do not apply to every program. Talk to several lenders about your circumstances to learn when you qualify to apply for a loan following a Chapter 13 discharge or dismissal.

Check your conventional loan eligibility (Feb 5th, 2021)

Alternative loan options with Chapter 13

Some alternative mortgage
programs (called Non-QM, Alt-A or Non-Prime) offer home loans to people in
Chapter 13 plans.

Non-Qualified Mortgages (Non-QM) do not meet the
standards for government or conforming mortgages. As such, they’re not eligible
for backing from Fannie Mae, Freddie Mac, or any federal agency.

Lenders assume extra risk when
they choose to fund these mortgages, and their costs are higher. But they may
be appropriate if you want to borrow higher loan amounts or wait less time
before borrowing.

Expect to pay higher interest rates and fees for one of these mortgages.

Chapter 13 dismissal vs. discharge: How soon can I apply
for a mortgage?

Mortgage lenders look differently at bankruptcy
discharge and bankruptcy dismissal.

A discharge means you’ve completed your court-ordered
repayment plan. Lenders look more favorably on this, because it means you made
your debt payments on time and worked hard to improve your finances.

If you want to buy a house after Chapter 13 discharge,
there’s no waiting period for an FHA, VA, or USDA loan (provided you meet loan
requirements).

For a conventional loan, there’s a 2-year waiting period
after Chapter 13 discharge.

But if your bankruptcy was dismissed rather than discharged, that waiting period is extended to 4 years for a conventional loan.

The longer waiting period accounts for the fact that
Chapter 13 discharge only happens after your repayment period is up — so it’s
been at least 3-5 years since your filing date by default. 

The major benefit of applying for a VA or USDA loan is that you don’t need to wait for your bankruptcy to be discharged or dismissed.

You can apply for these mortgages just 12 months into
your repayment plan.

That means you could qualify for a mortgage just one
year after you file for Chapter 13 — you don’t have to wait the full 5-7 years
for a conforming loan.

Technically the same is true for FHA, but many lenders
still won’t consider the loan until two years after discharge.

Verify your mortgage eligibility (Feb 5th, 2021)

Tips to qualify for a mortgage with Chapter 13

Just meeting the 12-month requirement for a government
loan doesn’t guarantee you’ll qualify.

You still need to meet lending guidelines for credit
score, income, employment, and down payment, among other things.

These will all need to be documented and verified during
underwriting.

And you may need to supply extra documents due to your
Chapter 13. Lenders might require copies of your bankruptcy petition and
discharge or dismissal documents. 

Finally, make sure you’ve budgeted correctly for
homeownership.

Remember that your mortgage payment will include taxes
and insurance as well as principal and interest. If you put less than 20% down,
it will also include private mortgage insurance or FHA mortgage insurance.

These added costs can increase a mortgage payment
substantially.

Before you jump into the application process, set aside
some time to think about your maximum budget for payments and how the cost of
homeownership will fit in with your debt repayment plan.

What lenders will approve a loan during Chapter 13?

VA, USDA, and, sometimes, FHA loans are available during
Chapter 13 bankruptcy. Most major lenders are authorized to do FHA and VA
loans. USDA mortgages are a little harder to find.

Remember that mortgage lenders can set their own lending
rules. Some may be more amenable to borrowers with Chapter 13 than others.

In addition, you’ll have better luck if you’re not
‘borderline’ — meaning you’re firmly eligible for the type of loan you want.

If you’re right on the edge of qualifying — for
instance, if your score is exactly 580, you have lower income, and you want an
FHA loan — it could be tougher to get approved.

You’ll need to shop around and compare your options.

All mortgage borrowers should shop for their best
interest rate. But for borrowers with Chapter 13 this is doubly important.

You’re not just shopping for a good deal; you’re shopping for a lender that’s willing to approve you.

Do you qualify for a mortgage?

Having a Chapter 13 bankruptcy in your credit history shouldn’t
stop you from getting a mortgage.

You might even be able to buy a home during
Chapter 13 if you’re in good standing with your repayment plan and you qualify
for the mortgage.

If you’ve been working hard to pay down debts and
improve your financial situation during Chapter 13, you might be able to get a
home loan a lot sooner than you think.

Verify your new rate (Feb 5th, 2021)

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