No one looks forward to having to file for bankruptcy. However, if you have filed and also own a home, you may be surprised to learn that you can, in fact, refinance an existing mortgage.
Refinancing comes with plenty of advantages. By lowering the interest rate you pay, it can help reduce your monthly payment. By extending your loan term — from, say, 15 years to 30 years — you may also be able to reduce your current mortgage costs. Refinancing also offers a way to either consolidate other debt, or produce cash for home improvements or other large expenses.
Still, It’s important to know that not every lender approaches post-bankruptcy refinancing the same way, and some have strict criteria, like long wait periods. At the same time, it’s worth noting that bankruptcy filers, as a group, pay considerably more for loans, according to a 2018 LendingTree study. The study found that the average lending terms offered to consumers three years after bankruptcy were $8,887 higher than those offered to consumers who had never had to file.
What to know about refinancing after bankruptcyBankruptcy gets a bad rap, but it’s also a way for consumers who are overwhelmed by debt to receive federal protection while they work to pay off obligations. While filing for bankruptcy is a very serious decision — and the move can stay on your credit report for years — it might be a reasonable move for your financial future if you’ve exhausted every other option.
There are several types of bankruptcy, and each might affect a potential refinancing differently, depending on factors like the discharge date.
A discharge date is the time when a debtor who has filed for bankruptcy is no longer legally liable for — or required to pay back — certain types of debt.
For Chapter 7 bankruptcies, a bankruptcy court will issue a discharge order relatively early — generally, 60 to 90 days after the date first set for creditors to meet. With a Chapter 7 bankruptcy, a debtor’s assets are liquidated, or sold, as a way to pay back creditors.
In Chapter 13 bankruptcies, a debtor who has a regular income is allowed to keep assets but also has to agree to a debt repayment plan, usually over three to five years. The debt is technically discharged only after it’s been paid off under the plan.
Even with a Chapter 7 bankruptcy filing, you may still be able to reaffirm, or pay off, certain debts with specific creditors. If you have a mortgage, this usually means re-entering a contract with your lender to affirm that you intend to repay part or all of your loan. As long as you follow through with mortgage payments, the lender is then legally obligated to refrain from repossessing your home and forcing a foreclosure.
For homeowners, one advantage to reaffirming a debt is that your mortgage payments will keep showing up on your credit report because lenders will be obligated to report them to the credit bureaus. Also, by reaffirming your mortgage, you might be able to renegotiate the terms of the loan, including the total amount and the interest rate.
According to federal court data, bankruptcy filings have been declining in recent years. Still, during the 12-month period that ended on June 30, 2018, 22,245 businesses and 753,333 non-businesses filed for bankruptcy, for a total of 775,578 filings.
If you own a home and absolutely must file for bankruptcy, be sure you understand how bankruptcy conditions differ.
“A Chapter 7 bankruptcy in essence is a liquidation and a fresh start, and people who don’t own highly appreciated assets are better off with this type of bankruptcy,” said James Shenwick, bankruptcy attorney at Shenwick & Associates in New York. “But if that person owns a highly appreciated house, or they want to keep a business, or they have an expensive piece of jewelry, then Chapter 13 is better.”
Here are the ways bankruptcies affect mortgages in particular:
Chapter 7 bankruptcy: Unlike a Chapter 13 bankruptcy, a Chapter 7 bankruptcy doesn’t have a repayment plan. Instead, an appointed trustee gathers and liquidates the debtor’s assets to pay off creditors which, in turn, lets the debtor start with a clean slate. Chapter 7 bankruptcies stay on credit reports for up to 10 years.
With a Chapter 7 bankruptcy, you have to wait two years after the discharge date before you can become eligible for a government-backed residential mortgage like a Federal Housing Administration (FHA) loan. For conventional home loans, the wait period is four years.
Certain types of debts — like child support payments and certain taxes — can’t be discharged, or basically forgiven, with a Chapter 7 bankruptcy filing. Mortgage debt can be discharged, but your lender will still have a lien on your home, which means you may lose it if the loan isn’t eventually repaid.
Chapter 13 bankruptcy: A Chapter 13 bankruptcy requires debtors to restructure their debts in order to pay them off over a period of three to five years. Compared to Chapter 7 bankruptcies, Chapter 13 filings carry the advantage of allowing homeowners to stop foreclosure proceedings, as long as they keep up with all mortgage payments due during the repayment period.
A Chapter 13 bankruptcy is often referred to as a “wage earner bankruptcy” because it offers a repayment plan to people who have regular income. You are eligible one year after the discharge of your bankruptcy for a government-backed home loan. With a conventional home loan, however, you’ll need to wait two years.
Chapter 11 bankruptcy: Chapter 11 bankruptcies are for business owners. They allow a business to follow a plan of rehabilitation or reorganization so it may continue to function while repaying debt.
FHA loans are subject to rules for after-bankruptcy refinancingIt’s entirely possible to get an affordable government-backed FHA loan for a refinance after declaring Chapter 7 bankruptcy, but you’ll need to do three things: Wait two years after your discharge, re-establish good credit during that time and avoid taking on more debt.
It’s also possible to become eligible for an FHA loan after just 12 months. However, you’ll need to prove your bankruptcy occurred due to circumstances beyond your control, and you’ll also need documentation to show you’re now managing your finances responsibly. Your lender will have to vouch for you on paper that the bankruptcy is unlikely to happen again.
To get an FHA loan after filing a Chapter 13 bankruptcy, you’ll need to show you made full, on-time mortgage payments for at least a year under your repayment plan, according to the U.S. Department of Housing and Urban Development. You’ll also need to get written permission from a bankruptcy court.
Conventional loans have stricter terms for after-bankruptcy refinancingConventional loans are not government-insured, so interest rates and credit score requirements tend to be higher than those for a government-backed mortgage like an FHA loan. For example, you can get an FHA loan with a credit score of just 500 (assuming you’re willing to put down a 10% down payment, or 580 if you only want to put down 3.5%. By contrast, conventional mortgages usually require a minimum score of 620.
According to Jeremy Schachter, branch manager at Fairway Independent Mortgage Corporation in Phoenix, Ariz., some lenders offer niche refinance loans that don’t require a waiting period, but these are adjustable-rate mortgages that come with higher fees.
“The majority of people fall in the FHA or VA loan buckets,” he said. “It doesn’t make sense if you’ve been through a bankruptcy to go with a loan with higher rates and fees.”
Tips on repairing credit after bankruptcyA bankruptcy typically takes a huge toll on your credit standing, cautioned Schachter, adding that the first thing any lender will look at is whether your credit has been re-established.
“While most bankruptcies happen not out of laziness but because of personal situations such as high medical bills, the worst thing you can do after a bankruptcy is be late on your debt,” he said. “It’s a red flag for lenders who think you should have learned your lesson.”
It’s usually easier to rehabilitate your credit if you file a Chapter 13 bankruptcy, rather than a Chapter 7 bankruptcy.
“In a Chapter 13, creditors are repaid about 10 or 20 cents on the dollar, so the debt is not fully wiped and lenders see that as more of a positive and are more willing to lend to you,” said Shenwick. Still, he added it’s possible to generally rehabilitate your credit even with a Chapter 7 bankruptcy in a year or a year-and-a-half by doing two things: spending as little as possible and saving as much as possible.
Shenwick’s best tip for a credit rebuild: Get a secured credit card, as repayments will show up on your credit history. Secured credit cards are “secured” by money you deposit, unlike regular credit cards, which require no deposits.
Schachter also recommended secured credit cards; he suggested getting a card to pay for very small expenses like gas or groceries, and then making payments on time.
“I see people who do it for six months and that dramatically increases their score,” he said. “It shows they repay debt. It’s a great way to establish or re-establish credit, even for people who don’t have a bankruptcy on file.”
The bottom lineYes, you may be able to refinance your home after bankruptcy, although you may have a waiting period. And you’re more likely to get a government-sponsored FHA loan rather than a conventional loan.
To boost your odds significantly, focus on repairing your credit, steering clear of piling on more debt and, if you filed a Chapter 13 bankruptcy, sticking to your repayment plan. Still, boosting your credit standing may be your biggest ally: According to the 2018 LendingTree study, five years after declaring bankruptcy, 75% of filers were able to boost their credit scores to a loan-eligible 640 or more.
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