Remember when declaring bankruptcy was kept a dirty little secret? The social stigma was bad enough, but the impacts of bankruptcy included employers who refused to hire anyone that went through the process and, of course, the ruinous end result of a credit score in the gutter.
The bankrupt were seen as irresponsible spendthrifts and offered little sympathy. The Great Recession changed these perceptions, thereby softening the stigma attached to those who are forced to take their debt to court to have it discharged.
If you’re among the estimated 800,000 Americans who file bankruptcy each year and dream of buying a home in the near future, read on for everything you’ll need to know about how to buy a home after bankruptcy.
Which type of bankruptcy is easier to recover from?
The two most common personal bankruptcy proceedings in the U.S. are known as Chapter 13 and Chapter 7. The latter will, with a few exceptions, eliminate all of your debt while the former (Chapter 13) leaves you on the hook to repay your debts over a certain period of time (typically three to five years).
If you hope to purchase a home after bankruptcy in the near future, a Chapter 7 proceeding is your best bet. Not only is it quicker, but because all of your debt is wiped out, your debt-to-income ratio is lowered and you now have a decent foundation on which to build the credit you’ll need to get a mortgage in order to buy a home after bankruptcy.
Your credit and your debt
Debt is a fact of life for many Americans, total household debt rose by $193 billion during the last quarter of 2019, according to CNN Business article “US households now hold a record $14 trillion in debt” published February 2020.
From outstanding student loan balances to credit card bills, a big chunk of our monthly income goes to pay this debt. And, although you no longer have to pay those discharged in a Chapter 7 proceeding, your former debt will be listed on your credit report as discharged through bankruptcy.
And, of course, the bankruptcy will put a huge dent in your credit score. According to top scoring model FICO, filing for bankruptcy can send a good credit score of 700 or above plummeting by at least 200 points. If your score is a bit lower—around 680—you can lose between 130 and 150 points.
The fact is that you are now considered a subprime borrower and will face higher interest rate offers from lenders than you would had you not claimed bankruptcy.
To prove to lenders that you’ve learned your lesson and can now use credit responsibly requires actually doing just that. As soon as possible, obtain a credit card, keep the balance below one-third of your credit limit and make all payments on time. This is the first step toward rebuilding your credit and it won’t happen overnight.
How long does it take to buy a home after bankruptcy?
There is some confusion among consumers about when the clock starts ticking for the waiting period to buy a home after bankruptcy. Lenders look at the discharge date, not the filing date. Once the process is complete, file the discharge paperwork in a safe, accessible place because your lender will ask for it when you finally apply for a mortgage.
While the waiting period to get a mortgage to buy a home after bankruptcy varies, plan on taking at least 18 to 24 months after the discharge. This may seem like a terribly long time, but not if you use the time wisely – to work on raising your credit score.
If you hope to obtain a Rural Development mortgage through the USDA, you will need to wait three years after the Chapter 7 bankruptcy is discharged and only one year if you filed Chapter 13 and can show that you’ve successfully stuck to the payment plan set forth by the court.
If your home was included in the bankruptcy proceedings you may have to wait significantly longer, so speak with a lender to find out the specifics to your situation.
For more information about buying a house after bankruptcy contact an expert, Rick Sheppard of RE/MAX Achievers today.