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Updated on Monday, February 4, 2019
Since 2012, 5.3 million Americans have gone through a bankruptcy. While there are often many reasons that people declare bankruptcy, the end result is often the same: Their credit takes a hit. For people who already had poor credit pre-bankruptcy, the dip will likely be more modest, but it will be very sizable for anyone who had good credit before bankruptcy.
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While a bankruptcy might seem dire, it’s not the end of the world. Even if you have a bankruptcy filing in your past, it’s still possible not only to buy a home but even to refinance an existing mortgage. And now is a great time to refinance: While mortgage rates are higher than a year ago, they’re still historically low. Below, we’ll walk you through what it takes to refinance after a bankruptcy.
What to know about refinancing after bankruptcy
The first thing to do when you decide to refinance your home after a bankruptcy is to learn about your options. There may be some restrictions based on your specific situation, the type of bankruptcy filed and the type of loan you want. It’s important to know the rules of refinancing so you can plan ahead and pick the right time to refinance.
There are two different types of personal bankruptcy:
Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, a debtor’s nonexempt assets are liquidated and those proceeds are used to pay down debts. People who file for Chapter 7 must pass a “means test” that proves their income is low enough to qualify. Whether someone can keep assets like a car or their home depends on the amount of equity they have in those assets and the rules of their state. Most states allow you to keep some equity in your home and car.
A Chapter 7 bankruptcy will remain on your credit report for 10 years. After the bankruptcy is discharged, there is a two-year waiting period for a government-backed mortgages (like a Federal Housing Administration loan), and a four-year waiting period until you can apply for a conventional home loan, one that is not backed by the federal government but meets the loan limits set by Fannie Mae and Freddie Mac.
Chapter 13 bankruptcy. Also known as a wage-earner’s plan, a Chapter 13 bankruptcy allows people with a steady income to create a plan that will help repay all or part of their debts over a period of three to five years. Chapter 13 may be an option if you don’t qualify for Chapter 7 bankruptcy because your income is too high and/or you want to repay your debts, prevent home foreclosure or want to keep nonexempt properties that would be liquidated under Chapter 7.
Chapter 13 bankruptcy has a waiting period of two years for a conventional home loan, but only one day after discharge for a government-backed loan.
Chapter 11 bankruptcy. Unlike Chapter 7 and 13 bankruptcies, Chapter 11 bankruptcy is mainly for reorganizing business debt. Chapter 11 allows a business to continue running while plans are being made to repay or discharge debts. Businesses that qualify for Chapter 11 bankruptcy can range from large corporations to small local businesses. Individuals with a debt load beyond the Chapter 13 limits may also file for Chapter 11 bankruptcy.
To refinance your home loan after bankruptcy, you’ll need to meet the same kind of qualifications as anyone else, including:
- Proof of income
- Employment history
- List of debts
- Sufficient credit score
- Debt-to-income (DTI) ratio appropriate for the loan (50% for government-backed loans, and 43% for conventional loans)
It’s important to note that if you’ve had more than one bankruptcy of any kind over the last seven years, there’s a waiting period of five years to refinance your mortgage.
What are the FHA rules for mortgage refinancing after bankruptcy?
The FHA insures loans from individual lenders, meaning that the government guarantees the loan if the lender can’t recoup their money from the borrower. This guarantee from FHA loans means that borrowers who might not qualify for a typical home loan may get a second chance with lenders.
The good news is that if you’ve declared bankruptcy, you can still get an FHA loan. However, there’s a waiting period, which is partially based on your bankruptcy type. Someone who filed Chapter 7 bankruptcy is eligible to apply for an FHA loans two years after the bankruptcy is discharged. That time may be reduced to one year if you can prove that you filed bankruptcy due to circumstances beyond your control and that you’ve been responsible with your finances since then. If you filed a Chapter 13 bankruptcy, you must make payments on the payment plan for one year, provide a record that all payments have been made on time and acquire written permission from bankruptcy court to enter into a mortgage transaction.
But that’s not all. There are still other factors that affect whether you can get an FHA loan after bankruptcy. It’s crucial to demonstrate that you’ve re-established your credit and finances after bankruptcy. To qualify for a FHA loan with a down payment as low as 3.5%, you’ll generally need a credit score of 580. If your credit score is lower than that, you’ll probably have to put down at least 10%. You’ll also need to have proof of income and steady employment.
What are the private lender requirements for mortgage refinancing after bankruptcy?
Working with private lenders is another option for homeowners who have gone through bankruptcy and who want to refinance their home loan. There are some substantial benefits to taking this path: Private financial lenders don’t have the same strict lending criteria as banks. Some may even be willing to provide a loan as soon as the bankruptcy is discharged, saving homeowners potentially years of waiting to refinance.
However, while these loans generally have less stringent requirements, there are some factors to consider: It’s important for the borrower to be financially stable and with a solid income. Also, private lenders usually require a much larger down payment because they are lending to riskier borrowers. The interest rates they charge will usually be much higher and the time allowed to pay back the loan is usually much shorter.
Tips on repairing credit after bankruptcy
There’s no way around it: Declaring bankruptcy will dent your credit. And whether you opt for a government-backed or private loan, repairing your credit will only work in your favor. Here are some steps you can take to get your credit in better shape after bankruptcy:
Reduce the amount of debt you owe. If you can afford it, put more money toward your balances on the cards with the highest interest rates while still making the minimum payments due on the rest.
Pay your bills on time. This is the biggest factor in determining your credit score, so paying your bills on time or early can really help your score.
Keep your balances low. If you must carry a balance on your credit cards, you shouldn’t use more than 30% of the available credit on any card.
What does it mean to reaffirm a debt, and do you have to do this in order to refinance after bankruptcy?
Reaffirming your debt means that you and your creditor have agreed that you’ll remain liable for a specific debt and its repayments through the bankruptcy process and beyond. In turn, they agree they will not repossess the asset as long as you continue making your payments.
Generally, if you want to keep your home after filing Chapter 7 bankruptcy, you should reaffirm your mortgage with your lender. This tells the lender you are committed to paying the mortgage debt and plan to keep your home. If you didn’t reaffirm your debt, you might still be able to refinance later, as long as you still legally own the home. However, if you didn’t reaffirm the debt, you can’t refinance the loan with the same lender because of bankruptcy laws. So you’ll have to find a new lender to refinance the loan.
You should reaffirm any debts if you intend to keep and pay them because this will create a positive credit history that will help you refinance later on. A case where you wouldn’t want to reaffirm would be if you want to let go of the debt during bankruptcy, especially if you know you won’t be able to afford payments on that debt in the future.
Bankruptcy can throw some roadblocks in the way to refinancing a home, but it shouldn’t stop you. With a little knowledge and preparation, it’s possible to enjoy the benefits of refinancing after declaring bankruptcy. Make sure to take your time selecting your loan, and compare the benefits from various lenders carefully to be sure you are getting a deal that’s right for you. It’s crucial to start rebuilding your credit as soon as possible after the bankruptcy. Bankruptcy is a setback, but with time and diligence, your credit can be repaired and you can even get loan terms comparable to borrowers without a past bankruptcy.
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