A house is the biggest investment most people make. It’s also a risk for the mortgage lender since a default puts them out of the money. That’s why lenders hesitate to work with consumers who have bad credit scores. However, there are options for home buyers who don’t have good credit, even if they recently incurred bankruptcy. This guide will unveil what you need to know when searching for homes shortly after filing for bankruptcy.
Understanding Bankruptcy
Bankruptcy will impact your credit score for years, but the type of bankruptcy plays a role in your FICO score impact and how much debt you owe. Here’s what you need to know about bankruptcies.
What is Bankruptcy?
Bankruptcy involves eliminating some or all of your debt through a legal process. It’s reserved for people who can no longer keep up with their financial obligations. Some debts, like student loans, are exempt from bankruptcy proceedings. If you end up with some debt after bankruptcy, you will likely receive a manageable payment plan.
Types of Bankruptcy
There are only two types of personal bankruptcies. Both show up on your credit report for several years and hurt your score, but one is more potent than the other.
- Chapter 7: Unsecured debt will get discharged. It’s a common option that involves the liquidation of assets. It’s possible to keep your property after a Chapter 7 bankruptcy. This type of bankruptcy will negatively impact your score more than a Chapter 13 bankruptcy.
- Chapter 13: This bankruptcy temporarily stops foreclosure and repossession actions and allows the borrower to establish a payment plan. Assets do not get liquidated. Repayment terms typically range from 3-5 years, with some of the debt possibly being discharged.
Can You Buy a Home After Bankruptcy?
It’s possible to buy a house after bankruptcy as long as you can make the monthly mortgage payments. However, a mortgage lender will review your credit history, and they must give you a loan while knowing that you recently filed for bankruptcy. That is an uphill battle, but it is still possible to receive financing.
How Does Bankruptcy Affect Home-buying?
A bankruptcy may restrict your home options. That’s because lenders may feel cautious about giving you a lot of capital and having you commit to a high monthly payment. You’ll likely need to make a bigger down payment, which can put some properties out of reach.
How Soon Can You Buy a Home After Bankruptcy?
The waiting period to buy a house after bankruptcy depends on the type of bankruptcy. Your credit score also plays a key role in determining how soon you can buy a property.
Waiting Periods for Different Types of Bankruptcy
Chapter 13 bankruptcies have more generous waiting times. You only have to wait a year before you can apply for loans. However, you’ll have to wait for two years after a Chapter 7 bankruptcy to apply for FHA loans and VA loans. The wait time extends to three years for USDA loans if you had a Chapter 7 bankruptcy.
Exceptions to Standard Waiting Periods
It’s possible to receive an exception if you can demonstrate the bankruptcy was out of your control. For instance, not everyone can anticipate losing a job or dealing with a significant increase in medical bills.
The Role of Rebuilding Credit
Mortgage lenders will review your credit score during the application process, regardless of whether you went bankrupt or not. Borrowers must fulfill the minimum FICO score requirements to be eligible for a loan. Rebuilding your credit after bankruptcy can help you buy a house sooner and give you more options.
Steps to Take Before Buying a Home After Bankruptcy
Buying a house is a long-term journey. It’s good to get started now so you are ready when you’re eligible to take out a home loan. Following these steps can help during the process.
Rebuilding Your Credit Score
It’s a good idea to get a copy of your credit report or see if your bank lets you see your FICO score for free. Knowing your current score will give you a benchmark and make it easier to track your progress. You will need a 500 FICO score or higher to get an FHA loan, and that’s if you have enough money for a 10% down payment.
A higher credit score will make the home-buying process easier when you are ready. Making on-time payments and paying your credit card balance in full each month are the two best ways to build credit.
Saving for a Down Payment
Start saving now instead of when you need the cash to buy a house. Reviewing your monthly bank account statements and your credit card bills can reveal unnecessary expenses. Trimming these costs will make it easier to save up. You may also want to consider a side hustle to increase your monthly income.
Creating a Budget and Financial Plan
A budget plan helps you minimize your monthly expenses and discover ways to build up your savings faster. Combining a budget plan with a long-term financial plan can put you where you need to be within a few years. You should map out how much money you want to put down and how much you have to earn each month to keep up with the mortgage and other living expenses.
Mortgage Options for Buying a Home After Bankruptcy
Aspiring homeowners can choose from several types of mortgages to buy a home after bankruptcy. These are some of the most popular financial products to consider.
FHA Loans
You can get an FHA loan with a 500 credit score if you make a 10% down payment or higher. Borrowers who can only make a 3.5% down payment must have a 580 credit score or higher. These loans have floors and ceilings for how much you can borrow to buy a property. This maximum amount varies based on an area’s cost of living. You will have to pay insurance premiums on this loan for at least 11 years, and it’s also possible that you pay them for the loan’s duration.
VA Loans
VA loans are exclusively for qualifying veterans, service members, and their spouses. These loans do not require any down payment, and credit score requirements vary for each financial institution. These loans do not have private mortgage insurance and must maintain competitive rates. Borrowers will have to pay a VA funding fee to take out this loan.
USDA Loans
These loans are exclusively for properties in rural areas. You can end up with competitive rates and terms, and you may not even have to make a down payment. Borrowers must meet income requirements to be eligible for a USDA loan.
Conventional Loans
Conventional loans are the most difficult loans to obtain. You need a 620 FICO score or higher to obtain one of these financial products. While you can get one of these loans with as little as 3% down, it’s best to put down at least 20% to avoid private mortgage insurance. If you recently filed for bankruptcy, you may have to put at least 20% down to improve your chances of getting approved.
Improving Your Chances of Mortgage Approval
Every optimization you make improves your odds of receiving a mortgage. Following these tips can give you some leverage when you approach mortgage lenders.
Reducing Debt-to-Income Ratio
The debt-to-income ratio measures your monthly debt payments as a percentage of your monthly income. Lenders want to see a low ratio and will give you better rates if your DTI is low enough. You can reduce your DTI ratio by increasing your income or paying off your debt. Most conventional mortgage lenders will not accept your application if your DTI is higher than 45%, but some lenders may work with you if you have a 50% DTI ratio.
Consistent Income and Employment History
Demonstrating a stable income tells lenders that you can keep up with monthly mortgage payments. If you are a seasonal worker with a fluctuating monthly income, a lender may perceive you as more likely to default on a mortgage. Getting a steady paycheck each week will put you in a better position when you apply for mortgages.
Seeking Professional Advice
You don’t have to navigate the mortgage application process alone. You can speak with a financial advisor or another professional to create a financial plan.
Choosing the Right Lender
Home buyers can choose from several types of lenders. These are some of the details to consider.
Specialized Lenders vs. Traditional Banks
Some lenders offer specialized services for people who have bad credit or want a specific type of loan. Traditional banks don’t offer as much specialization but may have better rates and terms.
Comparing Interest Rates and Loan Terms
A lower interest rate will reduce your monthly payments, so it’s important to compare offers from multiple lenders. The loan terms also play a significant role. A 30-year mortgage has lower monthly payments and is easier to obtain than a 15-year mortgage.
Importance of Pre-Approval
A pre-approval letter gives you a better idea of how much you can borrow and what type of rate you can receive. Sellers may also feel more confident working with you since they know you are serious about buying a home.
Potential Challenges and How to Overcome Them
Borrowers who recently endured bankruptcy will face several obstacles on the path to obtaining a mortgage. Planning for them in advance can help you during the mortgage application process.
Higher Interest Rates
You are going to receive higher rates than the average mortgage borrower. Anticipating them by saving extra money and growing your income will make it easier to keep up with the monthly payments. You should compare rates from multiple lenders to get the best deal.
Larger Down Payments
You might also have to make a larger down payment to make mortgage lenders more confident about working with you. The higher down payment will also minimize how much interest you pay during the loan’s lifetime.
Limited Loan Options
Not every mortgage lender will want to work with someone who has a bankruptcy in their credit history. You may have fewer loan options, but if you do research and reach out to lenders, you may find a good deal.
Conclusion: Preparation is Key When Buying a Home After Bankruptcy
It’s possible to buy a home even if you have recently incurred bankruptcy, but it won’t happen overnight. Saving money, keeping your expenses low, and looking for ways to build your income will put you in a better position to get a home. If you focus on those key areas, it will become easier to stay on top of monthly bills, a critical component for credit rebuilding.
It can take multiple years to successfully save up for a home. However, the benefits of homeownership, such as building home equity and finding yourself in a good neighborhood, can be worth the effort.
