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Buying a house after bankruptcy may sound like an impossible feat. Blame it on all those Monopoly games, but bankruptcy has a very bad rap, painting the filer as someone who should never be loaned money. The reality is that of the 800,000 Americans who file for bankruptcy every year, most are well-intentioned, responsible people to whom life threw a curveball that made them struggle to pay off past debts.
Sometimes filing for bankruptcy is the only way out of a crushing financial situation, and taking this step can really help these cash-strapped individuals get back on their feet. And yes, many go on to eventually buy a home. Only how?
Being aware of what a lender expects postbankruptcy will help you navigate the mortgage application process efficiently and effectively. Here are the steps on buying a house after bankruptcy, and the top things you need to know.
Types of bankruptcy: The best and the worst
There are two ways to file for bankruptcy: Chapter 7 and Chapter 13. With Chapter 7, filers are typically released from their obligation to pay back unsecured debt—think credit cards, medical bills, or loans extended without collateral. Chapter 13 filers have to pay back their debt, only it’s reorganized to come up with a new repayment schedule that makes monthly payments more affordable.
Since Chapter 13 filers are still paying back their debts, mortgage lenders generally look more favorably on these consumers than those who file for Chapter 7, says David Carey, vice president and residential lending manager at New York’s Tompkins Mahopac Bank.
How long after bankruptcy should you wait before buying a house?
Most people applying for a loan will need to wait two years after bankruptcy before lenders will consider their application. That said, it could be up to a four-year ban, depending on the individual and type of loan. This is because lenders have different “seasoning” requirements, which is a specified amount of time that needs to pass.
Fannie Mae, for example, has a minimum two-year ban on borrowers who have filed for bankruptcy, says David Reiss, professor of law and academic programs director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. The FHA, on the other hand, has a minimum one-year ban in place after a bankruptcy. The time is measured starting from the date of discharge or dismissal of the bankruptcy action. Generally the more time that passes, the less risky a once-bankrupt borrower looks in the eyes of a lender.
How to reestablish credit after bankruptcy
Once the bankruptcy process is over, reestablishing and maintaining creditworthiness is key to your financial health. Lenders will be looking for zero delinquencies postbankruptcy.
While you work to build new credit, don’t go overboard opening an extensive number of accounts, as this will work against you, advises Carey. Usually opening just a couple of revolving credit lines and paying them in a timely manner over the course of 12 months help to increase credit scores back to an acceptable level.
What to do before you apply for a mortgage
Before you apply for a loan, get copies of your three main credit reports, which detail the financial transactions (and transgressions) from your past. You will want to check these reports for errors such as a credit issue you resolved but is not reflected in your report.
“In some postbankruptcy cases, errors continue to report negatively on credit reports,” says Carey. These mistakes will drag down your overall credit score and reduce your chances of getting approved for the mortgage. So if you spot mistakes, work with the credit bureaus to correct the information they include.
Buying a house after bankruptcy: Ways to woo a lender
To start the mortgage process, lenders require a detailed letter explaining why you needed to file for bankruptcy in the first place. Ideally, the bankruptcy would have been caused by an extenuating circumstance beyond your control—such as the death of an income-contributing spouse, the loss of employment, or a serious illness.
In other words: A lender likes to see that you were hit with hard times that had a significant negative impact on your expenses or income, and made it impossible to meet your financial obligations. What a lender won’t want to see is someone with a die-hard shopping habit or lackadaisical attitude toward paying credit cards on time. If that’s you, you’ll have to prove you’ve changed.
Whatever the reason you filed for bankruptcy, lenders will need to properly document your extenuating circumstances, so be prepared to provide proof detailing your life event. Medical bills, a doctor’s note, a death certificate, or severance paperwork are all acceptable evidence that prove to lenders that you are a safe bet worthy of a home loan.
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