Will bankruptcy dash your dreams of home ownership? Not necessarily. Buying a house after bankruptcy presents unique challenges, but you don’t have to be shut out of home ownership forever. Many people succeed in rebuilding their financial lives and purchasing a home after a bankruptcy, and you can be one of them.
You’ll need to be patient and plan ahead if you intend to apply for a mortgage after a bankruptcy. Let’s look at some hurdles you’ll have to overcome and some steps that can help you put the keys to a home of your own in your hands.
Mandatory Waiting Periods
Many mortgage lenders and loan guarantors impose a mandatory waiting period that has to expire before you can think about buying a house after bankruptcy. These are not punishments. Waiting periods give you a chance to recover from your bankruptcy before extending yourself. There’s nothing you can do about these; you just have to wait them out. Some lenders or guarantors may reduce waiting periods if you can prove that factors beyond your control caused your bankruptcy.
☝️ If you were forced into bankruptcy by medical bills, a job loss, or similar circumstances you may qualify for a reduced waiting period.
Conventional Loans
Fannie Mae and Freddie Mac impose identical waiting periods after bankruptcy:
- If you filed for bankruptcy under Chapter 7 you’ll have to wait four years before applying for a mortgage. This can be reduced to two years with extenuating circumstances.
- Chapter 13 filers will have to wait two years after discharge or four years after dismissal. There is no reduction for extenuating circumstances.
These institutions don’t make mortgage loans but they are major buyers of mortgages made by banks and other lending institutions. Most conventional mortgage lenders follow their criteria. You can expect to encounter these requirements at any bank or other mortgage lender.
Government-Supported Mortgages
Mortgages backed by other government agencies may have shorter waiting periods. Let’s look at the requirements of the major government mortgage programs.
FHA loans are one of the most attractive routes to buying a house after bankruptcy. The waiting periods are more lenient than those of conventional loans. You’ll have to wait a minimum of two years after the discharge date of a Chapter 7 bankruptcy. Some loan servicers may impose longer waiting periods. After a Chapter 13 bankruptcy you may qualify for an FHA mortgage in as little as a year. You’ll have to comply with your payment plan and get the approval of your bankruptcy trustee.
If you qualify for a VA home loan you’ll have to wait two years after the discharge of a Chapter 7 bankruptcy and one year after filing a Chapter 13 bankruptcy. The waiting period for USDA rural home loans is three years after the discharge of a Chapter 7 bankruptcy and one year after filing a Chapter 13 bankruptcy. In both cases, you’ll need to have a good payment record and the permission of your trustee to get approved after a Chapter 13 bankruptcy.
Once the waiting period is over you’ll be able to apply for a mortgage. That doesn’t guarantee that you’ll be approved.
☝️ It’s important to use the post-bankruptcy waiting period to get your finances and credit score in order. That will help you prove to lenders that you can uphold a mortgage agreement.
Focus on Repairing Your Credit Score
Bankruptcy can pummel your credit, and you’ll need to whip that score into shape to get a mortgage. If you’re planning on buying a house after bankruptcy you’ll need to get your newly decimated credit score up to a lender’s minimum requirement.
👉 You’re typically looking at minimum scores of 580 for VA and FHA loans, 620 for conventional loans and 640 for USDA loans. Explore the credit score you need to buy a house for each different type of home loan.
If you can push your score higher you’ll have more options for lower down payments and favorable interest rates.
Rebuilding credit following bankruptcy is harder than building credit from scratch. Your bankruptcy discharge means you don’t have to pay some loans, but they will stay on your credit report for years. You can’t change that, so you’ll need to focus on reestablishing credit using new accounts.
Try a Secured Credit Card
The first step is to apply for a secured credit card. This is a financial tool available to people with poor credit or no credit history. You’ll put down a deposit and the amount of the deposit will become your credit limit. The issuer has your deposit, so their risk is minimal. Each time you make a monthly payment on time you take one small step toward better credit.
Stay aware of your credit utilization ratio on any card you’re using. Using less than 30% of your credit limit will help your credit, and even less is better.
⚠️ Your credit limit on a secured card is likely to be low, so you’ll want to keep a tight watch on what you put on your card.
Use a Credit Builder Loan
You may also consider a credit builder loan. Many banks and credit unions offer these products. The lender places the money you borrow in an account. You make the payments, and when the loan is paid off you get the lump sum in the account. The lender reports the loan as an installment loan, which helps you build credit.
☝️ You’ll also have access to a lump sum at the end of the payment period. That can be useful if you’re saving for a down payment!
Watch Those Bills!
Focus on paying every single bill on time. Keep a strict calendar to ensure that you’re making monthly payments. If you have a history of missing bill payments, use automatic payment options. Remember that even bills that don’t end up on your credit report can be sent to a collection agency if you don’t pay. The collection agency will report them and they will harm your credit score.
Pay your rent on time, every time, and keep your receipts. Mortgage lenders will want to see evidence that you’re handling your housing budget responsibly.
Monitor your credit score and reports. You don’t want to have errors dragging down your score when your record is already shaky. Look for incorrect details regarding closed accounts, outdated information and debt discharged by bankruptcy that’s still being listed by a creditor. You’re entitled to a free credit report once every year from each of the three main credit bureaus.
Bankruptcy probably left your credit in ruins, but since you have to wait anyway, you can use the waiting time to build it back.
☝️ Remember that newer information gets a higher weight in your credit score than old information. If you stay aware of your credit and work on improving it your score will recover.
Watch Your Debt to Income Ratio
Mortgage lenders pay close attention to your debt to income ratio. This is the percentage of your monthly income that you use to pay debts. When you emerge from bankruptcy your debt to income ratio is likely to be low, since many of your debts will be discharged. If you’re considering a mortgage, try to keep it low.
Most mortgage lenders will not lend to a borrower with a debt to income ratio higher than 43%. They generally prefer to see a ratio below 36%. Keeping your total debt level low will help your chances of getting a mortgage. Be aware of your debt to income ratio and try to keep it at the level that mortgage lenders want to see.
➗ Calculate your DTI: Debt-to-income Ratio Calculator
Build Your Savings
The post-bankruptcy period presents a good opportunity to build your savings. You won’t be buried in debt payments, so you should be able to set money aside. A large down payment makes mortgage approval easier. You’ll also have lower monthly payments and possibly a lower interest rate. Having a savings cushion can also prevent you from having to take on new debt if a financial emergency comes up.
The key to building savings is to have a budget and stick to it. Be sure to budget as much as possible for savings.
💡 Think of the money you save as a payment to yourself, and pay yourself first.
Draft a Letter of Explanation
Buying a house after bankruptcy involves the same process that someone who has never been through bankruptcy uses. You’ll need to fill out applications, submit personal financial information, negotiate with a seller’s agent, make an offer and have a home inspected before heading to closing. A letter of explanation of bankruptcy can boost your chances of being approved.
Lenders are always taking a risk when they approve a mortgage. You’re going to look like a riskier risk with a recent bankruptcy in your history. Building up your credit, paying all bills on time, keeping your debt to income ratio low and saving up a nice down payment are the most important things for getting yourself in the approval zone. A letter of explanation of bankruptcy is an extra step that can help to prove that you can be trusted to repay your mortgage even though there is a pretty big red flag in your history.
How to Write a Bankruptcy Explanation Letter
Provide details about your bankruptcy in the letter. Address issues directly and don’t make excuses. Explain what caused your bankruptcy and all of the financial changes you’ve made since then. Acknowledging past mistakes is a good way to get ahead of the question that will definitely be looming in the mind of the person reviewing your loan application. Any information you can share regarding long-term employment, a large emergency fund and a “perfect” payment record for all current bills can be useful. If circumstances beyond your control caused your bankruptcy, describe them. Be ready to provide evidence if the lender asks for it.
📘 Learn more about bankruptcy: Personal Bankruptcy 101
Get Pre-Qualified for a Mortgage
If you’ve finished your mandatory waiting period and your credit is strong enough to support a mortgage application, it’s time to move into the pre-qualification phase. This is a time to reach out to lenders to see how large a mortgage you can expect based on your current financial standing.
Pre-qualification serves two important functions. The first is to give you a good idea of your budget as you shop for your new home. The second is to prove that you’re qualified and prepared to make an offer.
If lenders offer you high interest rates, it might be worth it to delay your purchase and devote yourself to building up your credit. Better credit will generally get you a lower interest rate.
☝️ Even a fraction of a percent reduction in your interest rate can save you tens of thousands of dollars over the lifespan of a mortgage.
You Can Buy a Home After Bankruptcy
Buying a house after bankruptcy will not feel like a walk through a rose garden. You will have to wait. Remember that the waiting time requirements aren’t there to prevent people who have filed bankruptcy from ever owning homes. They simply provide a buffer that allows you to build up your credit and finances and prove that your past mistake really is in the past. They are there to protect you from overextending yourself too soon.
You will face suspicion and you’ll have to work hard to address it. Don’t blame the loan officers for being extra careful with your application. Put yourself in their shoes and think about what you’d want to see and hear if you were the one looking at your application. Of course they’re concerned about your creditworthiness. Anyone would be. It’s up to you to show that things have changed.
Bankruptcy is not a financial death sentence. Many people who have come out of bankruptcy go on to become successful, satisfied homeowners. If you make the right moves you can do it too!
