Implications Of Filing For Bankruptcy On Mortgage

A Chapter 7 bankruptcy wipes out your financial debt, including your mortgage, but you could lose your house. A Chapter 13 bankruptcy is more of a reorganization, and you can even catch up on payments as long as these are included in your plan.

What Happens to Mortgages in Bankruptcy?

Filers with a mortgage in foreclosure or significant home equity will turn to Chapter 13 bankruptcy to keep a home, not Chapter 7 bankruptcy. Find out why.

Understanding how Chapters 7 and 13 affect mortgages will help you keep your house in bankruptcy, and improving your credit score after your bankruptcy ends will help you purchase a new home. Here's how it works.

In Chapter 7 bankruptcy, you can keep your home if you're current on your mortgage payment, exempt all home equity, and continue paying the mortgage after bankruptcy.

In Chapter 13 bankruptcy, you must be able to continue paying your mortgage payment, catch up on any mortgage arrearages, and pay for any nonexempt home equity through the Chapter 13 repayment plan.

Most people qualify for a home mortgage within two to four years after completing Chapter 7 bankruptcy, and possibly sooner after Chapter 13.

Technically, a car loan is a "mortgage," too, but we don't discuss car loans in this article. Here's where you'll learn about vehicles in bankruptcy. After you understand what will happen to your home, try out our quick ten-question bankruptcy quiz. It will give you insight into your particular case and can help you spot potential bankruptcy issues fast.

Protecting Mortgages With a Bankruptcy Exemption

You likely already know that the first step to protecting a mortgage is checking whether you can cover your home equity with a bankruptcy exemption. Your state will probably offer one, maybe two bankruptcy exemptions that you can use for your house.

Look for a homestead exemption first. It's the exemption intended to protect home equity. If it isn't enough, your state might offer a wildcard exemption you can use on any property of your choice. Many states will let you stack a wildcard and a homestead exemption together, just be sure the wildcard exemption doesn't exclude real estate.

But what will happen if you can't exempt all of your home equity? The answer will depend on the bankruptcy chapter you file.

What Happens to Mortgages in Chapter 7 Bankruptcy?

Many people would rather file for Chapter 7 because it's quick with most Chapter 7 cases ending after about four months. But Chapter 7 won't help you save a house from foreclosure if you're behind on your mortgage.

Unlike Chapter 13, the chapter that lets you catch up on a mortgage when you fall behind, the Chapter 7 process doesn't have the proper mechanisms necessary to bring a mortgage current. So if you're behind on your mortgage when you file for Chapter 7, you should assume you'll lose the house.

But that doesn't mean you'll always lose your house when filing for Chapter 7. Here's what you'll need to do to keep your home:

  • Be current on your mortgage. When you buy a home using a mortgage instead of cash, the mortgage lender wants to be sure you'll pay as agreed. So you must agree to give the mortgage lender a lien on property you purchase with a mortgage. The lien rights let the lender take your home if you fall behind on the mortgage payment. For instance, suppose you're not current on the mortgage when you file bankruptcy. In that case, the lender can ask the court to lift the automatic stay order stopping collections or wait until the bankruptcy case closes to foreclose on the mortgaged property.
  • Protect all equity with an exemption. If you can't protect all of your home equity, the Chapter 7 trustee will sell the home and refund you the exemption amount. Anything remaining after sales costs and the trustee's fee goes to creditors.

Even if you can meet both Chapter 7 requirements, you'll want to learn about the valuable benefits available in Chapter 13. You might find other enticing reasons to file for Chapter 13, such as reducing the amount owed on the mortgage.

What Happens to Mortgages in Chapter 13 Bankruptcy?

Unlike Chapter 7, the Chapter 13 trustee won't sell any of your property, even if it's "nonexempt" and you can't protect it with a bankruptcy exemption. But that doesn't mean you get to keep more property in Chapter 13 than Chapter 7. Instead of the trustee selling the property and paying creditors, you'll pay creditors to keep the nonexempt property through the Chapter 13 plan.

Here's what you have to do to protect your mortgage and keep a house in Chapter 13:

  • Pay the monthly mortgage payment and arrearages through the plan. You must have enough income to cover the monthly mortgage payment, plus catch up on any outstanding mortgage arrearages. You can spread the overdue portion of your mortgage payment over the plan length.
  • Pay for nonexempt equity. You can exempt equity in Chapter 13 using the homestead exemption and possibly a wildcard exemption. But if the available bankruptcy exemptions don't cover all of the home equity, you'll reimburse creditors the nonexempt amount through the plan.
  • This might sound simple, but calculating a Chapter 13 repayment plan can be tough. Not only will you pay for any other nonexempt property you own, but you'll also pay some debts in full—like tax balances and support arrearages. You'll pay even more if your disposable income is high.

Reducing a Mortgage in Chapter 13 Bankruptcy

Can someone really reduce a mortgage balance in Chapter 13? Absolutely. But it's not easy. Here's how lien stripping and loan cramdowns work to reduce mortgages in Chapter 13.

If the mortgaged property is your residential home, and you can prove that you owe more on the mortgage than your home is worth, you can strip off a wholly unsecured junior mortgage loan. A mortgage loan is unsecured if, after selling the house, not one penny would be available to pay toward the stripped loan.

If the mortgaged property isn't your residence, such as a rental property, the rule is different. You can reduce the mortgage amount to reflect the property's value. But—and this is a big one—you must pay off the entire reduced mortgage balance in the repayment plan.

These options are tricky and require you to present admissible evidence of the value of your home and the amount owed on the mortgage at a motion hearing or adversary proceeding. A local bankruptcy lawyer can help you determine whether your property would qualify for a balance reduction.

Getting Your Lender to Modify Your Home Mortgage Loan

The lender might modify your home mortgage loan so that the payments are more affordable. Your local bankruptcy lawyer will be in the best position to explain your options.

Getting a Mortgage After Your Bankruptcy Case

One of the benefits of bankruptcy is that it erases debts and puts you in a better position to qualify for a home. Lenders have different qualification requirements, but if you improve your credit and have enough income to pay a monthly mortgage payment, you'll likely qualify after four years at the outset. Many people qualify even sooner. Learn more about getting a mortgage after bankruptcy.

Buying A House After Bankruptcy

Buying a house can be a challenge in itself, but if you’ve had to file for bankruptcy, owning a home may seem all the more difficult to achieve. However, it’s still possible regardless of whether you’ve filed for chapter 7 or chapter 13 bankruptcy.

Your biggest hurdles to getting a mortgage will be the mandatory waiting periods after you’ve declared bankruptcy, and rebuilding your credit score to qualify for a mortgage.

In addition, having a lower credit score from your bankruptcy may prevent you from qualifying for the lowest interest rate your lender offers. You may instead need to make a higher monthly mortgage payment or purchase a less expensive home compared to someone with excellent credit. That might feel like a bit of a blow when you’re trying to get your finances back in shape.

Still, the process of buying a home after bankruptcy is feasible. Here’s how.

Can I Buy a House After Bankruptcy?

Yes, you can buy a house after filing for bankruptcy. After all, bankruptcy is meant to help free you from certain debts to provide a fresh start.

You can always buy a home with cash after bankruptcy. However, a bankruptcy becomes more disruptive if you need to borrow money because you’ll have a damaged credit history that reflects your past repayment problems.

In addition to the bankruptcy itself, your credit report will show a history of late payments, judgments and collections associated with the payments you fell behind on. The higher your score was to start with, the more your bankruptcy will have brought it down.

However, the negative effect of your bankruptcy diminishes over time on your record, and you can rebuild your credit score by reestablishing a strong credit history.

How Soon Can I Buy a House After Bankruptcy?

Depending on the type of mortgage you qualify for, your lender, the type of bankruptcy you declared and the cause of your bankruptcy, you may have to wait one to four years after filing bankruptcy. You will also have to wait until your credit score has recovered enough for you to qualify for a mortgage.

First, let’s talk about the two most common types of consumer bankruptcy: chapter 7 and chapter 13. We’ll also show you how long you have to wait before you might qualify for certain common mortgage types.

Chapter 7

A chapter 7, or liquidation bankruptcy, discharges your debts. It will stay on your credit report for 10 years, but that doesn’t mean you have to wait 10 years to qualify for a mortgage.

Conventional Mortgage

To get a conventional mortgage that meets the requirements from Fannie Mae and Freddie Mac that many lenders follow, you’ll typically have to wait four years from the bankruptcy discharge or dismissal before getting a mortgage if financial mismanagement caused your bankruptcy.

Dismissal means you petitioned the court to let you enter bankruptcy, and they determined you did not qualify.

Discharge in a chapter 7 bankruptcy usually occurs about four months after filing.

However, the waiting period goes down to two years if you can document extenuating circumstances that caused your bankruptcy.

FHA Mortgage

The U.S. Department of Housing and Urban Development (HUD) requires borrowers to wait two years from discharge of a chapter 7 bankruptcy before they can qualify for an Federal Housing Administration (FHA) mortgage. The waiting period can be as little as one year if you can document extenuating circumstances.

VA Mortgage

Like HUD, the Departments of Veterans Affairs (VA) requires borrowers to wait at least two years from the date of chapter 7 discharge before closing on a VA home loan. If only one year has passed but circumstances beyond the borrower’s control caused the bankruptcy, it may be possible to get a VA mortgage before the two-year mark.

If it’s been less than a year, the only circumstance where it might be possible to get a VA mortgage is if the bankruptcy was caused by a self-employed borrower’s business failure, and the borrower has since obtained a permanent position and doesn’t have other credit problems.

USDA Mortgage

For a USDA loan, lenders are required to more carefully scrutinize the application of someone who has a chapter 7 bankruptcy that was discharged less than three years ago. If your bankruptcy was caused by extenuating circumstances that have been resolved and you have reestablished good credit, you may qualify sooner.

Chapter 13

A chapter 13 or payment plan bankruptcy gives you three or five years to make affordable payments to your creditors. After that, the bankruptcy court discharges your remaining debts. A chapter 13 bankruptcy stays on your credit report for seven years, but you don’t have to wait seven years to qualify for a mortgage. You will usually need the bankruptcy court’s permission to get a mortgage (or get any other type of loan or credit) during a chapter 13 bankruptcy.

Conventional Mortgage

To get a conventional mortgage that meets the requirements from Fannie and Freddie that many lenders follow, you’ll have to wait two years after discharge of a chapter 13 bankruptcy, or four years after a dismissal if your bankruptcy was caused by financial mismanagement. If you had extenuating circumstances, the waiting period is two years from the date of bankruptcy discharge or two years after a dismissal instead of four years.

FHA Mortgage

HUD requires borrowers to wait at least 12 months from the beginning of the chapter 13 bankruptcy pay-out period before qualifying for a mortgage. HUD also requires borrowers to get written permission from the bankruptcy court to get a mortgage.

VA Mortgage

The VA requires borrowers to be at least 12 months into a chapter 13 plan to qualify for a mortgage.

USDA Mortgage

If you’re applying for a USDA loan within three years of a chapter 13 bankruptcy, you may not qualify if you did not successfully complete your repayment plan. If you have a 12-month history of successfully meeting your new obligations under the plan, you may be eligible.

Multiple Bankruptcies

If a borrower has filed bankruptcy more than once in the last seven years, the standard waiting period grows to five years after discharge or dismissal for a conventional loan that will be purchased by Fannie or Freddie. If extenuating circumstances caused the most recent bankruptcy, the waiting period can go down to three years with Fannie in particular.

However, if you’re applying for a mortgage with another person and you each have one bankruptcy, that doesn’t count as multiple bankruptcies. Also, you could try getting a mortgage from a portfolio lender. These lenders have the freedom to be more flexible in their underwriting guidelines. But that doesn’t mean they’ll give you a loan if you’re a high-risk borrower.

Extenuating Circumstances

Every loan program makes exceptions for extenuating circumstances but defines those circumstances differently. Depending on what caused your bankruptcy, you may qualify for one loan type sooner than another.

Fannie Mae. Under Fannie guidelines, an extenuating circumstance is a “nonrecurring event” beyond your control that causes “a sudden, significant and prolonged reduction in income or a catastrophic increase in financial obligations.” Circumstances such as job loss followed by extended unemployment despite a robust job search, or the onset or significant worsening of an injury, disability or illness, would likely fall into this category, as would a divorce.

Freddie Mac. Freddie simply defines extenuating circumstances as “factors clearly beyond the control of the borrower”—as opposed to “financial mismanagement,” or “the borrower’s disregard for the payment of obligations when due.”

FHA. Under FHA guidelines, an extenuating circumstance is an “economic event” that reduced your household income by 20% or more for at least six months.

VA. VA guidelines describe extenuating circumstances as things like unemployment, a prolonged labor strike or medical bills not covered by insurance. Unlike Fannie, the VA does not put divorce into this category.

USDA. The USDA wants to know that the circumstances were beyond your control and unlikely to recur. For example, job loss, delay or reduction in benefits, illness or dispute over payment of defective goods or services. If the loan will reduce your shelter costs, that may also be a reason to approve your application before three years have passed.

For any type of loan where you’re claiming that extenuating circumstances caused your bankruptcy, you will need to show your lender documents that back up your claim. These documents might include a job layoff or severance letter, tax returns, medical bills or a divorce decree.

What Types of Mortgage Can I Get After Bankruptcy?

After bankruptcy and after fulfilling the required waiting period, you can get a conventional mortgage that follows Fannie’s or Freddie’s guidelines. You can also get an FHA mortgage, which you may have an easier time qualifying for because it has a lower minimum credit score requirement and shorter post-bankruptcy waiting periods. VA loans and USDA loans may be available to you as well if you meet the requirements.

How to Apply for a Mortgage After Bankruptcy

Applying for a mortgage after bankruptcy is not fundamentally different than applying for a mortgage without a history of bankruptcy. It just might take a bit more effort and paperwork to convince lenders that you can be trusted with a large loan.

Credit Repair

Your credit reports and scores will need to demonstrate to lenders that you’ve been able to manage credit responsibly since your bankruptcy. By making required monthly payments on time, paying down remaining debts and limiting new debt, you’ll be able to rebuild your credit score and establish a positive credit history. Getting a secured credit card can help you rebuild credit with minimal risk.

Some lenders may allow you to use nontraditional credit, such as evidence of on-time rental payments, utility payments, cell phone payments and insurance payments that aren’t automatically deducted from your paycheck to qualify for a mortgage.

But if the lender follows Fannie guidelines, you must be able to qualify with a traditional credit history and score to get a conventional mortgage after a bankruptcy. By comparison, to get an FHA mortgage, you can show that you’ve either reestablished good credit or chosen not to incur new credit obligations.

If you feel you need help with your credit score, you might consider using a credit repair company. But you might also find that after learning more about how credit scores work, you can fix your credit yourself.

Letter of Explanation

Your credit report doesn’t tell lenders whether the problem that pushed you into bankruptcy was an event beyond your control, poor financial management or a little of both. If you are applying for a mortgage within the extenuating circumstances timeframe after a bankruptcy, the lender may ask you for a letter of explanation. Your letter should include the following information:

  • Date and type of bankruptcy filing
  • Reason for filing
  • Evidence of reason for filing
  • Explanation of the change in circumstances that now makes it possible for you to afford a mortgage and associated expenses of being a homeowner

If you can make a strong case that the events that caused your bankruptcy were out of your control and have been fully resolved, you may be able to get approved for a mortgage, especially if you can demonstrate financial strength in other areas such as your credit score, debt-to-income (DTI) ratio and cash reserves.

What You Need For Preapproval

With or without a history of bankruptcy, you’ll need good enough credit to get preapproved. Here’s what that means for each loan type.

  • Conventional Fannie/Freddie mortgage: 620
  • FHA loan: 500 with at least 10% down; 580 with at least 3.5% down
  • VA or USDA loan: No minimum, but you are more likely to get approved with a score of at least 640

Gather these documents before you apply so lenders will be able to quickly make a preapproval decision on your loan.

  • Your Social Security card
  • Employment W-2 forms from the last two years
  • Pay stubs from your last two pay periods
  • Your two most recent statements from your bank and investment accounts
  • Tax returns from at least the past two years
  • Bankruptcy documents
  • Bankruptcy letter of explanation and any documentation of extenuating circumstances
  • Finally, if you’re an independent contractor, self-employed or a business owner, you will need to provide 1099 forms and/or profit and loss statements instead of W-2 forms and pay stubs.