Bankruptcy can be an event that would disqualify you for many loan types, however, FHA loans are generally more forgiving when it comes to bankruptcy, and it’s possible to qualify for an FHA loan even if you’ve filed for bankruptcy in the past.
Even so, there are requirements to meet depending on the type of bankruptcy filing. The requirements are slightly different whether you’ve filed for a Chapter 7 or Chapter 13 bankruptcy.
In this article, I’m going to discuss the conditions in which you can apply for FHA financing even after bankruptcy. I’m going to cover the waiting period for each bankruptcy chapter I mentioned as well as the other requirements of FHA loans.
FHA Loan After Bankruptcy – Yes, You Can!
Borrowers that don’t qualify for a conventional loan can pursue the option of FHA loans, which are less strict compared to conventional loans. Requiring a lower down-payment and accepting even a bruised credit score, FHA are deemed as easier to qualify for compared to conventional ones.
Borrowers with a past event of Chapter 7 or Chapter 13 bankruptcy will still be able to qualify for an FHA loan if they meet the requirements related to the necessary waiting period and requirements related to credit score and other FHA loan requirements.
Here are the general requirements for borrowers with a past bankruptcy event in their financial history:
The Single-Family Housing Policy Handbook (otherwise known as the Handbook 4000.1 of the Department of Housing and Urban Development) offers some insight into the waiting period that’s required for those who have filed for bankruptcy in the past.
The official guidelines state the following:
“The Mortgagee must document the passage of two years since the discharge date of any bankruptcy. If the bankruptcy was discharged within two years from the date of case number assignment, the Mortgage must be downgraded to a Refer and manually underwritten.”
The first mention of the waiting period required for borrowers with a bankruptcy filing is in the section dedicated to bankruptcy within the context of the mortgage underwriting process.
Because the FHA loan program is managed by the HUD, the requirements of this loan program are detailed in the HUD Handbook.
Therefore, there is a waiting period of two years before borrowers can qualify for an FHA loan. Besides the waiting period instituted for borrowers, the handbook also contains the requirement for lenders to document and verify the passage of this time by obtaining credit reports.
Should the credit report documentation not verify the discharge date, the lender must obtain the bankruptcy and discharge documents to verify the discharge date.
All these requirements relating to the passage of time and discharge documentation concerns automated underwriting, which the lender uses the automated underwriting system.
However, the passage I quoted above from the HUD Handbook also mentions manual underwriting.
Manual Underwriting Guidelines
Guidelines related to manual underwriting are laid down on page 258 of the HUD handbook, which discusses Chapter 7 bankruptcy and how this type of bankruptcy does not disqualify the borrower from an FHA loan if other conditions are also met.
In the words of the handbook:
“A Chapter 7 bankruptcy (liquidation) does not disqualify a Borrower from obtaining an FHA-insured Mortgage if, at the time of case number assignment, at least two years have elapsed since the date of the bankruptcy discharge.”
Apart from the 2-year waiting period, there are other conditions that the borrower must meet, namely:
- Borrowers have to re-establish good credit to meet the credit score requirements (580+) of the FHA;
- Borrowers must not have new credit obligations; and
- Borrowers must offer documented proof of their ability to manage their financial affairs in a responsible manner.
The mortgage lender must make sure that the borrower meets all these requirements and that they can document everything to the satisfaction of the mortgage lender.
The 2-year waiting period, however, is not entirely set in stone, because there are exceptions to this rule, which can cut in half the waiting period (but it can’t be less than 12 months).
If the borrower can demonstrate extenuating circumstances, which prove that the bankruptcy was the result of circumstances beyond their control, the waiting period can be reduced.
These are generally the requirements that borrowers must meet if they filed for bankruptcy in the past. However, the HUD guidelines make a distinction between Chapter 7 and Chapter 13 bankruptcy and discusses additional guidelines for Chapter 13 bankruptcy.
Chapter 13 Guidelines
One of the most important differences between Chapter 7 and Chapter 13 bankruptcy is that Chapter 13 involves a repayment plan, while Chapter 7 does not.
Those filing for Chapter 13 bankruptcy usually have regular income and can pay back at least a portion of their debt monthly through a repayment plan because they have enough money left at the end of the month.
After filing a Chapter 13 bankruptcy, borrowers can still get an FHA loan. The HUD Handbook states that:
“A Chapter 13 bankruptcy does not disqualify a Borrower from obtaining an FHA- insured Mortgage, if at the time of case number assignment at least 12 months of the pay-out period under the bankruptcy has elapsed.”
Beyond this requirement, the Handbook also sets additional requirements as follows:
- During the 12-month period the borrower can demonstrate satisfactory payment performance and that all payments have been made on time;
- The borrower must also receive written permission from bankruptcy court before they can enter into a mortgage transaction;
- The borrower must be able to also demonstrate that the events or circumstances that led to the bankruptcy filing are not likely to occur.
Other than these, the documentation requirements mentioned above are the same even when requesting an FHA loan after Chapter 13 bankruptcy filing.
The lender must make sure that all these things are properly documented and they can use bankruptcy or discharge documents or credit reports.
On the whole, if the general conditions for FHA loan application are met and the additional requirements in case of bankruptcy are met, getting an FHA loan should not be a problem.
Can You Get an FHA Loan After Foreclosure?
When a borrower has a foreclosure on their credit history, getting approved for an FHA loan depends on the time that has elapsed since the foreclosure and whether the borrower has worked to re-establish good credit.
The HUD Handbook 4000.1 directly addresses the question of whether a borrower with a foreclosure on their credit report can get approved for a FHA loan or not.
Here’s what the HUD Handbook says:
“A Borrower is generally not eligible for a new FHA-insured Mortgage if the Borrower had a foreclosure or a Deed-in-Lieu (DIL) of foreclosure in the three-year period prior to the date of case number assignment.”
Therefore, while generally a borrower is not eligible for an FHA loan, there are exceptions that will allow a borrower with a past incident of foreclosure to qualify for this type of loan.
After the 3-year waiting period and if the borrower has established good credit and has shown financial responsibility, they can qualify for an FHA loan.
The 3-year waiting period starts “on the date of the DIL or the date that the Borrower transferred ownership of the Property to the foreclosing Entity/designee.”
If the borrower can demonstrate extenuating circumstances that were beyond the control of the Borrower (e.g. serious illness or death of a wage earner) and the borrower has re-established good credit since the foreclosure, the 3-year waiting period can be overlooked by the lender.
While a divorce isn’t usually considered an extenuating circumstance, the HUD Handbook states that “An exception may, however, be granted where a Borrower’s Mortgage was current at the time of the Borrower’s divorce, the ex-spouse received the Property, and the Mortgage was later foreclosed.”
Therefore, even in case of a foreclosure, a borrower may be able to qualify for a FHA-insured mortgage loan if they meet the requirements set out by the HUD and the lender’s requirements, which may require higher standards compared to the minimum FHA loan requirements.
FHA loans are designed to offer a financing opportunity to borrowers with a bruised credit score and a lower down-payment. While the FHA loan program does have some strict requirements, it’s generally considered easier to qualify for than conventional mortgage loans.
But the appeal of an FHA loan doesn’t exclusively lie in the less strict credit and down-payment requirements, but also in the way this loan is more forgiving even in the case of bankruptcy or foreclosure giving borrowers a second chance to start over and prove their creditworthiness.
Therefore, if a borrower has filed for Chapter 7 or Chapter 13 bankruptcy, they can still apply for FHA financing.
The HUD requires that they meet additional requirements related to the 2-year waiting period (12-month in some cases), on-time payments and good re-established credit that will prove to mortgage lenders that the borrower has become more financially responsible and events like this are not likely to repeat.