You have a sizable amount of equity in your home that you want to convert into cash. A home equity loan could be an option. But if you recently filed for bankruptcy, will you qualify for funding? It depends, but a recent bankruptcy filing doesn’t necessarily mean you’ll automatically receive a denial. Here’s what you need to know to help boost your chances of getting approved.
Understanding Home Equity Loans
As the name suggests, home equity loans let you tap into the equity you’ve built up in your property or the amount of the home you own outright. There are two primary types to choose from: the standard home equity loan and the home equity line of credit (HELOC). This guide focuses on the latter.
What is a HELOC and How Does It Work?
A HELOC is a line of credit that acts as a second mortgage. It works like a credit card, giving you access to a pool of cash you can borrow against as needed up to the credit limit during the draw period. The amount you can access is determined by the amount of equity you have in your home.
The draw period typically spans five to 10 years, and you borrow, repay and borrow again until the draw period ends. Most lenders require interest-only payments on HELOCs during this window, and you’ll only pay interest on the amount you borrow. Once the draw period ends, you enter the repayment phase, typically lasting up to 20 years. You’ll need to repay both principal and interest, so expect your payments to be higher.
In most instances, HELOCs are capped at 85% of your home equity minus your outstanding mortgage balance. So, if your home is worth $325,000 and you owe $200,000 on your home loan, you can potentially get a HELOC of up to $76,250 ($325,000 * .85 – $200,000).
It’s also worth noting that HELOCs generally come with variable interest rates. So, your monthly payments during the draw and repayment periods will fluctuate as rates change with market conditions.
What is Bankruptcy?
Bankruptcy is a legal process that helps individuals or businesses struggling with debt. It is designed to give you a fresh start or reorganize your debts by eliminating the debt balances or allowing you to resolve them through a repayment plan under the protection of the bankruptcy court.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, or liquidation, gives you a fresh start. The court appoints a trustee to sell your non-exempt assets and use the proceeds to repay your creditors. It usually takes a few months to complete Chapter 7 bankruptcy, and you can begin rebuilding your financial health sooner rather than later.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy, or reorganization, grants you a repayment plan to satisfy your creditors. You aren’t required to give up your assets, but you must adhere to a repayment plan that spans three to five years.
Can You Get a HELOC After Bankruptcy?
Getting approved for a HELOC after bankruptcy can be difficult, but it’s not impossible. Most lenders have a waiting period before they’ll consider you for funding – typically two years for Chapter 7 and one to two years following the completion of the repayment plan for Chapter 13.
How Bankruptcy Affects HELOC Eligibility
When you file for bankruptcy, your credit score takes a tumble of a hundred points or more. The filing lingers on your report for 10 or seven years for Chapter 7 bankruptcy and Chapter 13 bankruptcy, respectively. Fortunately, the impact starts to diminish over time and could position you for approval after a few years have passed, and you’ve started rebuilding your credit health.
Are There Any Advantages of Getting a HELOC Post-Bankruptcy?
Securing a HELOC after bankruptcy has its share of advantages.
Access to Home Equity
The primary draw for most homeowners is the ability to access home equity. As previously mentioned, you can withdraw from your HELOC and use the funds however you see fit. Some homeowners cover costly home repairs, upgrades or other big-ticket expenses.
Potential for Lower Monthly Payments
Although HELOCs come with variable interest rates, they often start off lower than what you’ll get with traditional fixed-rate personal loans. So, you could save a bundle in interest and get more affordable monthly payments on your HELOC.
Possibility of Debt Consolidation
If you’re saddled with high-interest debt, a HELOC also provides a pathway to consolidate those pesky balances into a single loan – preferably with a lower interest rate. Doing so helps make the balances more manageable and could save you a ton of interest over time.
Challenges and Considerations of Getting a HELOC After Bankruptcy
There are also potential downsides to keep in mind.
Higher Interest Rates
Lenders may see you as a riskier borrower post-bankruptcy and give you a higher interest rate on a HELOC. So, it’s worth shopping around to get the best deal. You should also work to improve your credit score over time to potentially secure lower rates.
Limited Loan Amounts
Applying for a HELOC post-bankruptcy could also mean access to a lower credit limit. Even if you have a large amount of home equity, the lender may not approve you for the maximum HELOC, as they evaluate other components of your financial profile when deciding the amount and terms of your credit line.
Stricter Lending Criteria
Again, expect more stringent lending guidelines when you apply for a HELOC post-bankruptcy. Lenders want reassurance that you’ll repay what you borrow and will take the extra steps to ensure you’re a good fit for funding.
How to Get a Home Equity Loan After Bankruptcy
When you’re ready to apply for a HELOC, here’s how to move forward.
Eligibility Criteria
Familiarize yourself with the general lending criteria. Each lender has specific guidelines, but most assess your employment history, income, credit score and debt-to-income (DTI) ratio. They also check to confirm you’ve passed the waiting period.
Ideally, you want a credit score of at least 620 and a DTI below 43% to be considered for a HELOC. Remember that a stronger credit score and lower DTI may help boost your approval odds.
Documentation Required
Gather the following documents before applying to help expedite the lending process:
- Proof of income
- Proof of assets
- Recent mortgage statements
- Bankruptcy discharge papers
The lender may request additional documentation, but having these handy gives you a headstart.
Comparing Lenders and Terms
Don’t settle for the first lender you find. Explore several lenders and inquire with each other about options they offer for post-bankruptcy applicants.
If possible, get pre-qualified and compare loan offers. Pay attention to interest rates, loan terms and fee schedules. Also, look at reviews from past and current borrowers to get a feel for what to expect if you decide to do business with the lender.
Rebuilding Credit After Bankruptcy
Filing for bankruptcy doesn’t mean your credit health is doomed forever. Here are some strategies to help rebuild it.
Importance of Credit Score
Your credit score is a vital component of your overall financial health, impacting your ability to get credit cards, housing, loans and even jobs in some industries. It also affects what you pay for auto insurance in some states. So, it’s worth taking the necessary steps to improve your credit score.
Steps to Improve Credit Score
Here are a few tips to help you get started:
- Pay your bills on time.
- Bring any past due accounts current.
- Don’t close old accounts that are in good standing.
- Get a secured credit card or credit builder loan.
- Only apply for new credit as needed.
- Monitor your credit report for changes.
- Dispute inaccuracies promptly.
Timeframes for Credit Recovery
Generally, it may take 18 to 24 months to see significant improvement in your credit score. Some actions, like paying off existing debts and making timely payments, can show results quickly.
Securing new lines of credit and implementing sound financial habits will also help rebuild your credit over the long term.
Avoiding Future Financial Pitfalls
To keep your finances on track over time, here are some pitfalls to avoid.
Budgeting and Financial Planning
A realistic budget helps keep your finances on track by telling your money where to go. That way, you won’t overspend and can begin saving while meeting financial milestones.
Building an Emergency Fund
It’s also worth incorporating your savings goals into your budget. That way, you’ll have an emergency fund to fall back on when life happens.
Seeking Professional Financial Advice
A professional can help create a comprehensive financial plan, offer investment advice, and provide tips on managing debt and improving credit scores. Be sure to only work with a reputable financial advisor.
Conclusion: The Key to Successfully Getting a HELOC After Bankruptcy
Getting a HELOC after bankruptcy is tough, but you can overcome the hurdles with the right strategy. Focus on rebuilding your credit to show lenders you can handle debt responsibly. And be sure to shop around to find the most suitable lender for your financial situation.
