A bankruptcy will not prevent you from getting a mortgage. However, there are some special tips that you should use to minimize the impact of your bankruptcy, and improve your chances of getting approved for the mortgage you need to buy the home you desire.
Check All Credit Reports to Confirm Bankruptcy Reported Properly
Chances are high that your credit reports after bankruptcy will contain inappropriate information. This inappropriate information will prevent you from rebuilding your credit scores and getting a mortgage.
You’ll need to be proactive. Pull your credit reports about 60 days after your bankruptcy discharge, and review them carefully to make sure all of your discharged, pre-bankruptcy creditors are reporting that their claim has a zero balance and that it was “included in bankruptcy” or “discharged in bankruptcy.”
If not, then you’ll need to go through the dispute process described in this previous post.
Gather all the Needed Documents in Advance
Even without having filed bankruptcy, there is a mountain of documentation a lender requires to underwrite a mortgage application.
Having a bankruptcy in your file only adds to the size of that mountain. With that said, preparing all of the documents that are likely to be requested in advance of your actually applying for the loan will provide you a huge advantage.
You’ll want to keep the underwriting loan officer’s attention so that your application is processed as smoothly and as efficiently as possible.
If you provide him or her all of the documentation necessary to underwrite your loan immediately, up-front, without any break in the momentum of the process, then you will be well ahead of the game.
Plus, you’ll minimize your stress in what can be a tremendously stressful process.
The documentation likely to be requested is as follows:
- W2’s from current and past employers
- Paycheck stubs for last 3 months
- Bank statements for last 2 years for all bank accounts
- Most recent 2 years tax returns
- Gift letter (if using gift funds for your down payment and/or closing costs)
- List of your debts and assets
- Proof of rent payments, if applicable
- Credit Reports from all three bureaus
- Profit and loss statements if self employed
- Signed real estate purchase contract
- Proof of additional income
- Divorce order, if applicable
- Bankruptcy schedules and discharge order
Ride out the Waiting Periods
Depending on whether your bankruptcy is a Chapter 7 vs. a Chapter 13, as well as the type of mortgage that you are seeking, there will likely be a period of time you are required to wait before you are able to get approved.
You’ll likely be required to wait for 4 years from the date you receive your discharge order; however, some conventional lenders require as little as 2 years. You’ll want to inquire with the particular lender before submitting a conventional mortgage loan application.
If you filed a Chapter 13 case, you’ll likely be required to wait for at least 2 years following discharge.
For an FHA-backed mortgage loans you’ll need to wait a minimum of two years from the date of your bankruptcy discharge before you’ll successfully qualify for the mortgage.
If you’re involved in a Chapter 13 bankruptcy, you may be able to get a mortgage while you’re still completing your Chapter 13 payment plan; provided that you’ve successfully made at least twelve months of plan payments on time, and the Bankruptcy Court signs off on your proposed mortgage, then you will be able to successfully close a FHA loan during bankruptcy.
VA loans offer the best opportunity for those who qualify. You don’t need a down payment, you don’t need good credit, and you’ll be fine as long as at least two years have lapsed since your bankruptcy discharge.
If you’re in a Chapter 13, then as with the FHA Mortgage, you must demonstrate at least 12 months of successful plan payments and get Court approval.
For a USDA loan you must wait three full years from the date of your Chapter 7 bankruptcy discharge. If you were/are a Chapter 13 debtor, then the requirements are the same as with FHA loans, in that you must demonstrate 12 months of successful plan payments and get Court approval.
Be Prepared to Explain the Bankruptcy
When you apply for the mortgage, the lender will ask you to explain the circumstances which led to your filing bankruptcy. You also may be asked what actions you’ve taken to rebuild your credit scores.
Having a prepared explanation of the circumstances giving rise to your bankruptcy, and the things you’ve done since the bankruptcy discharge to improve your situation, will go along way in moving your application through the underwriting process smoothly.
Timing a Job-Change or Self-Employment
As a general rule, a lender is going to want to see stable employment for at least the most recent two years. If you’re planning to change jobs, or thinking about start a new business full-time, WAIT.
Just wait until you’ve closed on your new home. Otherwise, a recent job-change or employment status may alone be the determinant of whether you successfully get approval for a mortgage.
Get Pre-Approved First (as opposed pre-qualified)
Pre-approval requires you to submit an underwritten mortgage loan application. A lending decision will be made prior to your commencing your home search.
As long as your financial position does not change, you are approved for the mortgage. This enables you to confidently go about your home search knowing exactly the price range you can afford.
A pre-qualification does not come with any actual loan commitment, and a pre-qualification is provided without any review of your credit reports, income documentation, bank statements or other documentation which would be necessary to underwrite a mortgage loan.
Basically, a pre-qualification is mostly useless other than to give you a general idea of what type of house you can afford.
The 22% Rule
Typically, the general consensus among personal financial professionals is that your mortgage principal, interest, taxes and insurance should not exceed one-third (1/3) of your monthly net income.
I’ve always stressed that my past bankruptcy clients stick to a 22% rule, in that the monthly mortgage payment, including taxes and insurance, not exceed 22% of their monthly net income.
This way there is no doubt the home is affordable, and that you have a significant amount of disposable income each month to fund emergency savings, fund investment and payoff the mortgage early.
Fixed Rate Mortgages Only
A fixed interest rate gives you predictability and control over your personal finances. If you do not understand what your mortgage payment will be in the future, how can you budget, plan and prepare?
Getting a variable rate mortgage is a gamble which is never worth taking in my opinion.
Expect Problems – Prepare Accordingly
Before submitting a single mortgage loan application, do an honest assessment of your personal financial position. Be your own underwriter.
What is your debt-to-income ratio?
Have you had two years of stable employment history?
If you see weaknesses in your circumstances which might prevent your loan application approval, then wait to apply and fix your situation. Having a loan application denied only puts you further away from getting an approval.
What you do after applying for a mortgage is going to be considered in whether you ultimately get a loan approval.
You may have a perfect loan application, but if you apply for three new credit cards and finance a new car after submitting an application, you’ll sabotage yourself.
Do not apply for any new lines of credit or debt finance after submitting your loan application.
There you have it. Your bankruptcy is not going to prevent you from getting a mortgage. Rebuild your credit scores, ride out the waiting periods, and stabilize your income.
If you do, you’ll be sure to get approved for the mortgage you desire.
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