Curve

Mortgage with a Chapter 13 bankruptcy

Gina Pogol
Gina PogolThe Mortgage Reports Contributor

In this article:
If economic conditions pushed you into filing for Chapter 13 bankruptcy protection, that doesn’t have to keep you from buying a house. You can get a mortgage with a Chapter 13 bankruptcy — in some cases even while you are still in the plan and making your payments.

  1. Depending on the circumstances of your case, you may be able to qualify for a mortgage while still working through a Chapter 13 plan. FHA, VA and USDA (Rural Housing) lending programs do approve borrowers who are in a court-supervised payment plan.
  2. Chapter 13 bankruptcies in which filers made all payments as required are considered “discharged.” The waiting period for these Chapter 13 bankruptcies is two years from the discharge date. Note that it can total seven years from the filing date before you can get a conforming loan (five-year plan payment and an additional two-year waiting period)
  3. A severe illness or disability, a company layoff, or death of the primary wage-earner would likely qualify as extenuating circumstances. Talk to several lenders about your circumstances to learn when you qualify to apply for a loan following a chapter 13 discharge or dismissal.
Verify your mortgage eligibility (Oct 15th, 2018)

Not your Dad’s bankruptcy

Today, filing for bankruptcy is not usually a financial death sentence. In many cases, mortgage lenders will say yes to your loan application while you are still working through a Chapter 13.

Related: Post-bankruptcy buying guide for Chapter 7 and Chapter 13

For some loan programs, you may need to wait a year or two after you file to qualify for a mortgage. This article explains how to find a lender to say “yes” to your mortgage with a Chapter 13 bankruptcy.

Bankruptcy can make future mortgages easier to get

Bankruptcy is a constitutional right that’s designed to help you get a fresh start following a financial disaster.

According to a New York Federal Reserve Bank study, people who file for bankruptcy get through the ordeal in better financial shape and with less damage to their credit score than those in similar financial stress who don’t file for bankruptcy.  

Bankruptcy has a harsh immediate impact, but the long-term result of bankruptcy on filers’ credit scores is positive – about 60 points higher than that of consumers in financial distress who choose not to file for bankruptcy.

The chart below shows the difference in credit scores of insolvent (broke) individuals who filed or did not file for bankruptcy. You can see that the bankrupt consumers recovered much more quickly than the non-filers.

mortgage with chapter

Chapter 7 vs Chapter 13 bankruptcy

Bankruptcy law is divided into chapters.

Most consumers file either a Chapter 7 bankruptcy, which discharges all qualifying debts immediately or a Chapter 13, which sets up a three to five-year payment plan to repay some or all of the debt.

Most mortgage lenders look more favorably on applicants who file Chapter 13 than those who file for Chapter 7.

That’s because Chapter 13 filers have made an effort to repay at least some part of their debts.

Related: Buying a home with a VA loan after bankruptcy

In fact, some mortgage lenders treat a Chapter 13 filing the same way that they’d consider a debt management plan through a credit counseling service — as evidence that you’re trying to fix your finances and fly right.

Credit reporting agencies favor people who file a Chapter 13 over those who file for Chapter 7.

Chapter 7 appears on a credit report for up to 10 years after the filing date, while Chapter 13 must be removed in 7 years.

Verify your mortgage eligibility (Oct 15th, 2018)

Qualifying for a mortgage with a Chapter 13 bankruptcy

Depending on the circumstances of your case, you may be able to qualify for a mortgage while still working through a Chapter 13 plan. FHA, VA and USDA (Rural Housing) lending programs do approve borrowers who are in a court-supervised payment plan.

In addition, some alternative mortgage programs (called Non-QM, Alt-A or Non-Prime) offer home loans to people in Chapter 13 plans.

Government-backed loans

The FHA, VA or USDA may approve you while in a Chapter 13 plan if:

  • You qualify for the loan under the program’s underwriting guidelines.
  • At least 12 months of the repayment period must have elapsed, and you must have made all required payments on time.
  • The bankruptcy Trustee or a Bankruptcy Court judge gives you written approval to take out the loan.

Related: Mortgage with a 640 credit score

If you have completed your plan and meet program guidelines, no additional criteria apply to get approved for government-backed mortgages.

 Alternative loans for chapter 13 borrowers

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 set standards for the least risky home loans.

These are what the Act calls “qualified” mortgages.

Related: 7 mortgages with low minimum credit score requirements

There is no requirement that every loan meet the QM standard. Loans that don’t are considered non-QM loans. They are riskier than QM loans.

Lenders assume extra risks when they choose to fund these mortgages, and their costs are higher. But they may be appropriate if you want to borrow higher loan amounts or wait less time before borrowing.

Expect to pay higher interest rates and fees for one of these mortgages.

Conforming (Fannie Mae and Freddie Mac) mortgages

Conforming mortgage programs treat Chapter 13 bankruptcies differently, depending on their cause and their conclusion.

Chapter 13 bankruptcies in which filers made all payments as required are considered “discharged.”

The waiting period for these Chapter 13 bankruptcies is two years from the discharge date. Note that it can total seven years from the filing date before you can get a conforming loan:

  • Five-year plan payment
  • Additional two-year waiting period

Filers who fail to complete the plan may have their bankruptcy “dismissed.” They probably still owe their creditors and will have to wait at least four years from the dismissal date.

Filers with multiple bankruptcies in the seven years prior to applying will have to wait at least seven years.

Conforming loan exceptions for extenuating circumstances

A two-year waiting period is permitted after a Chapter 13 dismissal if extenuating circumstances can be documented. There are no exceptions permitted to the two-year waiting period after a Chapter 13 discharge.

For multiple bankruptcies, extenuating circumstances can get your waiting period cut to three years.

What are “extenuating circumstances” for Chapter 13 mortgages?

The creators of popular loan programs realize that people who file a Chapter 13 do so for good and bad reasons. An example of a “bad” reason is mismanaging money – or put more simply, living above one’s means.

Related: “Boomerang” buyers can get a mortgage after a deed-in-lieu of foreclosure

Most loan program underwriters consider a “good” Chapter 13 one that was caused by extenuating circumstances. Freddie Mac offers a clear test for determining if a bankruptcy has extenuating circumstances:

  • Were the events beyond your control?
  • Has the problem been resolved?
  • Is the problem likely to happen again?

Fannie Mae describes extenuating circumstances as “nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.”

A severe illness or disability, a company layoff, or death of the primary wage-earner would likely qualify as extenuating.

Understand that these tests do not apply to every program. Talk to several lenders about your circumstances to learn when you qualify to apply for a loan following a chapter 13 discharge or dismissal.

What are today’s mortgage rates?

Following the US election, mortgage rates have increased. But they are still remarkably affordable and may be lower today than they will be in the coming 12 months. Find out what rates you qualify for after a Chapter 13 bankruptcy.

Verify your new rate (Oct 15th, 2018)