How to Qualify for an FHA Loan After Bankruptcy
If your homebuying plans were put on hold due to a bankruptcy, take heart: You may qualify for an FHA loan after a bankruptcy that has been discharged within the last one or two years. Although a bankruptcy may stay on your credit report for seven to 10 years, FHA guidelines allow you to qualify for a loan sooner, depending on whether you filed a Chapter 7 or Chapter 13 bankruptcy.
Steps to take to qualify for an FHA loan after bankruptcy
The guidelines for qualifying for an FHA loan after bankruptcy vary based on what type of bankruptcy was discharged. There are two types of bankruptcy available to individuals, and each comes with its own rules for getting an FHA loan.
Chapter 7
When you file a Chapter 7 bankruptcy, all your assets are sold and the proceeds are used to pay creditors and eliminate all eligible debt. It’s the most common kind of bankruptcy and is the best option for people who don’t have enough income to repay their debts.
You are eligible for a new FHA loan two years after your bankruptcy is discharged. A “discharge” is a court order that releases you from the debts included in the bankruptcy, and the date stamp on the discharge starts the clock on your waiting period. You must also meet two other requirements besides the waiting period:
- You must have re-established good credit. Lenders will pay close attention to how you’re managing credit after a bankruptcy, especially your recent payment history on any new debt and how much new debt you’ve taken on.
- You must explain the reason for the bankruptcy. A letter of explanation is typically required so the lender can understand what happened and how things have changed financially for the better since the bankruptcy was discharged.
You may also be eligible for FHA financing 12 months after a bankruptcy discharge, if you can prove the bankruptcy was caused by circumstances beyond your control. The FHA calls these “extenuating circumstances,” and they include:
- The death of a wage-earning spouse
- Serious illness
- Getting laid off
- Natural disaster that destroys all of your belongings
Be prepared to submit extensive documentation to prove extenuating circumstances and get this exception.
Chapter 13
A Chapter 13 bankruptcy is designed to give individuals with a consistent income a court-ordered repayment plan. When a Chapter 13 is filed, the individual (called a debtor in this case) works with a trustee to repay creditors on a schedule over a three- to five-year period. When the payment plan is completed, any remaining eligible debts are discharged.
To get an FHA loan, you have to prove you’ve made on-time payments on the Chapter 13 plan for at least one year. The lender will require documentation to show the payment dates and you’ll need written permission from the court to apply for the mortgage.
THINGS YOU SHOULD KNOW
The Federal Housing Administration (FHA) backs loans made by FHA-approved lenders to borrowers with lower credit score minimums and qualifying requirements than conventional loans allow. They do this by charging FHA mortgage insurance, which is paid by the borrower to protect lenders against losses if you default and they have to foreclose. Borrowers often choose FHA loans after a bankruptcy because the two-year waiting period is far less than the four year waiting period required after a bankruptcy for conventional loans.
5 tips to improve your finances after bankruptcy
In addition to meeting the minimum waiting periods, you’ll need to show the lender your financial house is in order to meet the “re-established good credit” guideline. Bankruptcy can have a massive impact on your credit scores, but the extent of the damage depends on your overall credit profile.
Someone with a pre-bankruptcy credit score in the mid-700s might see a 100 point or more drop, while a borrower who already had a low score due to a history of mismanaging their credit might not see a dramatic difference. Regardless of where your credit scores were before your bankruptcy filing, you’ll need to demonstrate good financial management skills when you apply for a new FHA loan.
Here are some tips to spruce up your finances after a bankruptcy:
- START SAVING. Good savings habits can help you realize your dream of homeownership by showing the lender you have not only the funds needed for an FHA loan, but a cash cushion to avoid running up debt if a future financial crisis hits. To get an an FHA loan after a bankruptcy, you should plan on saving up for:
- A down payment of your own. The benefit of FHA loans over many other loan programs is that you can get an FHA loan with a down payment as low as 3.5%, and the funds can be gifted. However, having your own down payment saved up shows lenders you’re in the habit of saving up your own money to cover purchases.
- Closing costs. The type and amount of FHA closing costs you’ll pay varies depending on your lender and your location. But you can generally expect to pay anywhere from 2% to 6% of the home’s purchase price in closing costs.
- Cash reserves. FHA loans may require borrowers to have enough cash reserves to cover at least one monthly mortgage payment after coming up with a down payment and closing costs.
- An emergency fund. Although FHA lenders don’t require it, extra cash in the bank may compensate for a low credit score, so it’s worth it to set aside as much rainy day cash as possible. Experts suggest you have three to six months’ worth of your current expenses in an emergency fund in case a financial disaster strikes.
- APPLY FOR A SECURED CREDIT CARD. Immediately after your bankruptcy, you might have a hard time qualifying for a new credit card, but opening a new secured credit card and using it responsibly can help you improve your score. However, limit yourself to a small balance ($200 or less) and when you use the card, pay the balance to zero if possible.
- PAY YOUR BILLS ON TIME. Your payment history accounts for 35% of your FICO Score, so make every effort to pay your bills on time. Set up payment reminders or enroll in automatic payments through your bank or lender to ensure you’re not delinquent again. Avoiding any late payments on your credit report, especially in the 12 months leading up to applying for an FHA loan, is really critical after bankruptcy.
- KEEP BALANCES ON REVOLVING CREDIT ACCOUNTS LOW. Use revolving credit accounts sparingly. The amount you owe on these accounts makes up 30% of your FICO Score. The lower your credit utilization rate (how much of your available credit you use), the better, as far as your credit score goes. A good rule of thumb is to keep your credit utilization rate below 30%, both on a per-card basis and overall — for example, if you have a secured credit card with a limit of $500, you should charge less than $150 (30% of $500) in any given billing period, then pay off the statement balance in full.
- 5. DON’T OPEN A LOT OF NEW ACCOUNTS. The average age of all of your credit accounts makes up about 15% of your FICO Score, and new accounts make up 10%. Opening several new accounts within a short period of time lowers your average account age, and the numerous hard inquiries into your credit report may lower your credit score. It may also be a red flag that you’re having a hard time paying your bills without resorting to credit use.
FHA loan requirements
Even if you’ve met the waiting bankruptcy discharge waiting period, you’ll still need to qualify based on standard FHA loan requirements:
| Minimum credit score | 580 with 3.5% down payment 500 with 10% down payment |
| Income requirements | Not applicable |
| Debt-to-income ratio | 43% with exceptions available up to 50% with higher credit scores and cash reserves |
| Property requirements | Home must be safe and habitable per HUD guidelines |