FHA Loan Requirements After Chapter 13 Bankruptcy
This article covers FHA loan requirements after a Chapter 13 bankruptcy:
Many homebuyers are often told they cannot qualify for an FHA loan during the Chapter 13 Bankruptcy repayment plan. Many are also told they need to wait two years after the Chapter 13 Bankruptcy discharged date. This is absolutely not true. In this article, we will discuss the following topics:
- We will discuss how homebuyers and homeowners can qualify for an FHA loan after filing a Chapter 13 Bankruptcy just after one year into the repayment plan with trustee approval.
- How to qualify for a mortgage after filing Chapter 13 Bankruptcy without having the 13 discharged.
- Getting a home mortgage during Chapter 13 Bankruptcy repayment versus discharged.
- Can I get a home purchase and/or refinance FHA loan during Chapter 13 Bankruptcy repayment?
- Can I get a cash-out FHA loan during the Chapter 13 Bankruptcy repayment plan?
Gustan Cho Associates are experts in helping borrowers get approved and closed on FHA loans during and after Chapter 13 Bankruptcy on both home purchase and refinance transactions.
Can I Qualify for an FHA Loan After Filing and Discharge of Chapter 13 Bankruptcy?
Under HUD guidelines, home buyers and homeowners can qualify for an FHA home loan after filing and discharge of Chapter 13 bankruptcy. A Chapter 13 bankruptcy usually takes five years to complete. Under a Chapter 13 plan, the bankruptcy trustee sets a monthly payment for the debtor.
The debtor pays into the plan every month for up to five years. When the bankruptcy period is up, any remaining balances are discharged. You may be able to apply for an FHA mortgage while paying into a Chapter 13 plan after one year into the repayment plan.
Does the Chapter 13 Bankruptcy Need to Get Discharged?
You do not have to wait until the Chapter 13 Bankruptcy is discharged. Also, there is no waiting period after the Chapter 13 Bankruptcy has been discharged to qualify for an FHA loan at Gustan Cho Associates. Many lenders may require a two-year waiting period after the Chapter 13 Bankruptcy discharged date to qualify for an FHA loan.
At Gustan Cho Associates, we do not require a waiting period after the Chapter 13 Bankruptcy discharged date for borrowers to qualify for an FHA loan on both purchase and refinance transactions. This holds true on cash-out refinance FHA loan transactions.
Chapter 13 bankruptcy is very much like a debt management plan from a consumer credit counseling agency. Instead of making your monthly payment to a counselor, you make it to a bankruptcy trustee. To apply for an FHA mortgage while in a Chapter 13 bankruptcy, you must get the approval of your bankruptcy trustee.
How to Qualify for a Mortgage After Chapter 13 Bankruptcy
Mortgage lenders treat applicants with Chapter 13 bankruptcies differently from those who file Chapter 7 bankruptcy. The difference between the two is the Chapter 13 filers pay some or all of what they owe their creditors over time, while most Chapter 7 filers discharge their debts without repaying anything. These are called “no asset” filings.
FHA mortgage lenders are more likely to approve applicants who file Chapter 13 than those who file for Chapter 7 bankruptcy. That’s because Chapter 13 filers repay at least some part of their debts.
You can see the difference in waiting periods following the different filings:
- Chapter 7 bankruptcy: 2 years after discharge
- Chapter 13 bankruptcy: 12 months after filing
Once your Chapter 13 bankruptcy is discharged, you can apply for an FHA mortgage right away. This holds true without any special conditions. But you absolutely need written permission from your bankruptcy trustee to apply for an FHA home loan while still paying into a Chapter 13 plan if you are in an active repayment plan.
Many people worry about the trustee not approving a mortgage during a Chapter 13 Bankruptcy repayment plan. There is no reason to worry. Bankruptcy Trustees will always sign off on a mortgage for a home purchase and/or a refinance. This holds true as long as the home is a reasonable home purchase and not a mansion.
How to Get Approval From Your Bankruptcy Trustee
It’s best if you choose a loan amount that won’t increase your housing expense by too much. “Too much” is generally defined as $100 or 5%, whichever is less.
Next, you or your attorney will file a motion with your bankruptcy court requesting approval to buy a home with an FHA mortgage. Note that it can take up to 45 days to even schedule the hearing for your motion. So don’t go house shopping before you’ve nailed down your approval from the court as well as your lender.
Your motion should include this information:
- The terms of the proposed home purchase including the purchase price, down payment amount, down payment source, and the monthly payment including principal, interest, property taxes, and homeowners insurance
- Proof of your current income
- Your budget including the new house payment
- How it will impact your creditors
Normally, if the new mortgage won’t result in less money available to your creditors, the trustee will approve the request to finance a home with an FHA mortgage. Your chances are decent if your new house payment won’t exceed your current housing expense by much or at all.
If your new mortgage payment would be $1,000 more than your current rent, however, you’ll have a hard time. In that case, you may be able to get trustee approval by finding extra income — perhaps a part-time job or by renting out part of your home to a roommate.
FHA Mortgage Less Than 2 Years After Chapter 13
If you apply for an FHA mortgage within two years of filing for Chapter 13 bankruptcy, your lender cannot underwrite your application electronically. Instead, a human underwriter reviews your application manually, which leaves a lot of your application information open to interpretation.
You want to make your application as strong and convincing as possible for the human who will be deciding your fate.
A good loan officer can help you with the extra things you can do to improve your chances. It’s very helpful, for instance, if you take steps to re-establish credit and prove that you can manage your finances and pay your debts.
However, FHA guidelines specifically state that an applicant’s choice to not use credit should not be cause for denial of a mortgage.
It’s to your advantage if you can show that your bankruptcy was caused by a situation over which you had no control and was therefore not your fault. Here are some examples of mitigating circumstances that might get you better treatment:
- Massive layoff at your workplace
- A catastrophic illness that increased your expenses or decreased your income substantially
- The death or illness of the primary wage earner in your household
- Self-employment significantly harmed by a global event like the coronavirus pandemic of 2020
- Being a crime victim
Note that the FHA specifically mentions that divorce is not a mitigating circumstance. Nor is the inability to sell your home after a job transfer to another location.
You also need to show the human underwriter that you are unlikely to experience another bankruptcy. For instance:
- You found another job after losing the old one and have passed your probation period
- You’ve regained your health after a serious illness or medical bankruptcy
- You use credit conservatively now and your income is more than sufficient to cover your current expenses plus the new mortgage
Work with your lawyer and loan officer to make your case with your lender. An experienced loan officer will work with your bankruptcy attorney in getting your trustee approve your mortgage.
Verification of Rent Requirement
All manually underwritten FHA home loans require verification of your housing expense, whether it’s rent or a mortgage payment. You’ll need to prove that you’ve paid your rent or mortgage on time over the last 12 months.
If your mortgage appears on your credit report, you don’t have to do anything more. If you pay rent, your lender will send a Verification of Rent form to your landlord. Alternatively, you can provide 12 months of canceled checks or your bank statements proving on-time payment.
But what if you’re living rent-free? Homebuyers saving up a down payment often live with family or friends rent-free for a period of time. Many lenders find this unacceptable and will decline your mortgage application. That’s not a requirement of the FHA program; it’s an overlay.
Gustan Cho Associates imposes NO OVERLAYS and can qualify borrowers living rent-free as long as the reason is to save money for a down payment on the home purchase.
Underwriting Guidelines for FHA Loans During Chapter 13
There are additional requirements to qualify for an FHA home loan while in a Chapter 13 repayment plan. You need:
- A minimum credit score of 580
- At least 3.5% down (but more is better if your qualifications are not strong)
- Sellers can contribute up to 6% for closing costs. This should free up more of your cash for a down payment or reserves
- Documentation of your income — pay stubs and W-2s for wage earners (two years), tax returns with all schedules for self-employed borrowers, and those who earn at least 25% of their income from commissions or bonuses
- Income that is enough to cover your current debts plus your new mortgage payments
- Underwriters prefer it if your total monthly debt payments (living costs like utilities and child care don’t count) don’t exceed 31% front end and 43% back end with no compensating factors
- Maximum 37 front end and 47 back end with two compensating factors
- 40% front end and 50% back end if you have two compensating factors
No late payments during and after the bankruptcy filing.
What Are Compensating Factors
Compensating factors are things that lower the risk to your lender. Here are a few:
- Additional down payment than the minimum required
- Cash reserves and savings shows strength
- Conservative use of credit and high credit limit
- Lower debt to income ratio
- Other income not used to qualify as income such as boarder income, money from a new part-time job, bonus or self-employment income that’s you’ve received for less than two years
- A high credit score (yes, you can have a high FICO score even after a bankruptcy)
Chapter 13 Dismissal Instead of Discharge
Not every bankruptcy filing results in the discharge of your debts. Sometimes, your filing is dismissed instead of discharged.
A discharge means you’ve completed your court-ordered repayment plan. You made your bankruptcy plan payments on time and improved your finances. If you want to buy a house after Chapter 13 discharge, there’s no waiting period for an FHA, VA, or USDA loan. For a conventional loan, there’s a 2-year waiting period after Chapter 13 discharge.
A dismissal might happen if the court finds that you were not honest in your filing — for instance, that you hid income or assets or ran up bills right before filing bankruptcy. You can also request a dismissal if you suddenly acquire the money to repay your creditors, decide that you don’t want to file bankruptcy, or find that you can’t afford the Chapter 13 payments.
When you have a bankruptcy dismissal, it’s as though there was no bankruptcy filing at all. If you qualify for a mortgage, there is no waiting period. More likely, though, the same problems that caused you to consider bankruptcy will continue to affect your credit and make it hard to obtain financing.
Alternatives to FHA Loans In Chapter 13 Bankruptcy
FHA mortgages are probably the cheapest and best home financing available after a bankruptcy. However, they’re not always possible. You can’t use an FHA loan to purchase an investment property. Or to buy a condo in a non-FHA-approved community. If you owe money to a government agency, you may not be eligible for government-backed mortgages. Finally, the FHA limits the amount it will guarantee and you might need to borrow more.
In that case, your options are conventional (non-government) financing from a mortgage lender or private “hard money” financing from individuals or groups of investors. Some alternative mortgage programs (called Non-QM, Alt-A or Non-Prime) offer home loans to people in Chapter 13 plans.
These loans are riskier to lenders because there is no mortgage insurer or government agency to bail them out if you default. But they may be appropriate if you want to borrow higher loan amounts or wait less time before buying a home.
Expect to pay higher interest rates and fees, and to make a higher down payment as well.
Please contact Gustan Cho Associates at 262-716-8151 or text us for a faster response. Or email us at [email protected] Gustan Cho Associates is a mortgage company licensed in multiple states with no lender overlays on government and conventional loans.