AFTER A CHAPTER 7 “STRAIGHT BANKRUPTCY”
Perhaps surprisingly, a previous Chapter 7 bankruptcy filing is in some ways better than a foreclosure in qualifying for a new FHA mortgage. Instead of the 3-year waiting period, you can qualify by waiting only 2 years after the “discharge” in your case. Note that “discharge” is the legal write-off of all or most of your debts. It happens almost always at the conclusion of your case, usually only 3 or 4 months after its filing.
As the HUD Handbook 4155.1 on home loans puts the 2-year rule:
Chapter 7 bankruptcy (liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. During this time, the borrower must have
• re-established good credit, or
• chosen not to incur new credit obligations.
See the Borrower Credit Analysis Section of the HUD Handbook 4155.1 at Chapter 4, section C.2.g.
The last part about choosing “not to incur new credit obligations” can be very significant on a practical level if it is enforced as it states. Although it’s usually wise for most people to take tangible steps to reestablish good credit after a Chapter 7 case, for understandable reasons that often doesn’t happen. You may just decide after finishing the bankruptcy that you don’t need credit for a while. You may want to avoid its temptations. You may just want a break from it all. Being able to qualify for an FHA-approved mortgage in only 2 years in spite of not rebuilding your credit could be very helpful, although each individual lender has latitude in how this language is applied.
But it gets even better. The HUD Handbook 4155.1 further states:
An elapsed period of less than two years, but not less than 12 months, may be acceptable for an FHA-insured mortgage, if the borrower
• can show that the bankruptcy was caused by extenuating circumstances beyond his/her control, and
• has since exhibited a documented ability to manage his/her financial affairs in a responsible manner.
This gets back to the “extenuating circumstances” we saw in the foreclosure section above. This means that in the right situations you can qualify for an FHA mortgage only a year after completing your Chapter 7 case.
And as with a prior foreclosure, you need to explain the “extenuating circumstances.” You need to show your “ability to manage [your] financial affairs in a responsible manner.” Do these with a thorough and compelling letter or memo to the lender. You essentially need to convince the lender that the events that led to your bankruptcy filing are not going to happen again.
AFTER A CHAPTER 13 “ADJUSTMENT OF DEBTS”
In certain respects it’s even better in a Chapter 13 case, in that you may qualify for an FHA mortgage while you are still in the midst of your case.
Chapter 13 cases involve a 3-to-5-year payment plan, during which you almost always only pay part of your debts—often only a small part—and at the end of that period the remaining debts are “discharged”—written off. You may qualify for an FHA mortgage one year after FILING the case, while it is still ongoing.
As the HUD Handbook 4155.1 on home loans puts this 1-year rule:
A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA-insured mortgage, provided that the lender documents that
• one year of the payout period under the bankruptcy has elapsed
• the borrower’s payment performance has been satisfactory and all required payments have been made on time, and
• the borrower has received written permission from bankruptcy court to enter into the mortgage transaction.
See the Borrower Credit Analysis Section of the HUD Handbook 4155.1 at Chapter 4, section C.2.h.
The two conditions beyond getting past the “one-year of the pay-out period” are straightforward.
First, you and your attorney propose the Chapter 13 payment plan based on your budget, and the bankruptcy court approves that plan with a court order. So you are already legally obligated to make the monthly plan payments and all related payments on time.
Second, you are generally not allowed during a Chapter 13 case to incur any new credit, and certainly not for the purchase or refinancing of a home, without the bankruptcy court’s written permission.
So you qualify for an FHA mortgage after a year into a Chapter 13 case as long as, during that year, you did what you’d already agreed you would and were required to do, and now got the court’s already required permission.
As for qualifying AFTER your Chapter 13 case is over, a 2-years-since-discharge rule applies similar to the 2-year Chapter 7 rule. However here the HUD Handbook 4155.1 does not refer to an “extenuating circumstances” exception but rather that qualifying would require a heightened degree on scrutiny by a “Direct Endorsement” underwriter.
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