Sometimes consumers can feel as if it’s the end of the world when financial problems seem too big to handle. At first maybe it’s a late payment on a credit card and then maybe later it’s two late payments. Then perhaps an automobile payment is missed and it’s close to the point where the owners are deciding whether or not to sell the car to pay off the note and maybe pay off other bills at the same time. Such financial problems typically are the result of major changes in a consumer’s financial condition as a result of a drop in income.
A drop in income can be the result of an employer forced to reduce payrolls or even let employees go due to bad business conditions. It’s also common for someone to be forced to leave work due to medical issues which forces them to stay at home. Or maybe it’s the result of an extended illness and the person loses the job. Whatever the external factors, it can get to the point where it’s a choice to try and repay the debts over time or file for bankruptcy. When a bankruptcy is filed, many consumers report it was like a large weight lifted off their shoulders. The bankruptcy was the result of events out of the borrower’s control and was the option of last resort.
There are two types of consumer bankruptcy, a Chapter 13 and a Chapter 7. A Chapter 13 is often referred to as a “wage earners” plan. Under this option, a court trustee compares available monthly income and sets up a repayment schedule for outstanding debt. The creditors aren’t required to accept the repayment plan but most usually do as the other option would be to file a suit and obtain a judgment, a lengthy and costly option.
The other bankruptcy plan is Chapter 7. A Chapter 7 wipes out all dischargeable debt and the consumers no longer have to repay the creditors included in the filing. Note the term, “dischargeable.” Some obligations cannot be included in a bankruptcy petition. If someone owes federal or state income taxes there will be a lien filed against the individual and attached to any real property that individual owns, including a home. Such taxes cannot be discharged. Neither can property taxes assessed against the consumer. Mechanic’s liens, liens that are filed by a contractor when work is done on a home, cannot be discharged. If the filer owes any support payments to a former spouse or child support, such payments cannot be discharged. Student loan payments cannot be dismissed. A mortgage cannot be discharged, either. What can be discharged? Typically any consumer debt incurred and still outstanding such as credit cards, installment loans.
What happens when someone can’t pay the mortgage and the home goes into foreclosure? As far as how a lender reviews a credit report, the worst things on the report will be a bankruptcy and a foreclosure. In fact, a foreclosure is considered by a lender to be a worse mark than a bankruptcy, although not by much. But if a mortgage is included in the bankruptcy and the home is ultimately foreclosed upon, that’s a double whammy.
But that doesn’t mean getting a home loan won’t happen for another 10 years down the road. A Chapter 13 bankruptcy is removed from a credit report seven years after the filing date while a Chapter 7 remains on the credit report for 10 years. The longer time period for the Chapter 7 is due to the debts being wiped out and not repaid through a Chapter 13 program. But again, having a bankruptcy on your credit report doesn’t mean you have to wait seven or 10 years before you’re able to obtain a conventional mortgage. A conventional mortgage is one where the lender assumes all the risk for making the loan whereas government backed loans such as VA, FHA and USDA do carry a guarantee to the lender in case of default. With a government backed loan, there is a two year waiting period from the discharge date of a Chapter 7.
With a conventional loan, the mandatory waiting period before being able to qualify for a new conventional loan is three years from the date of discharge when the mortgage was included in the bankruptcy. Once the mortgage is included with the bankruptcy, it’s the discharge date lenders look for. But the discharge date and the three year waiting period can also be held up if the foreclosing lender delays or even never transfers the deed back to the owners. If the lender delays transferring the deed back from the borrowers to the lender, that can mean an extended waiting period.
In the instance of a Chapter 7 bankruptcy it is the bankruptcy attorney’s responsibility to make sure the deed has been changed to have the mortgage lender’s name on it. Technically this means if the transfer hasn’t been made the borrowers still own the home as their names still appear on title. To speed this up, call the lender and make the transfer request. If this doesn’t work, send a certified letter to the lender. Put the home up for sale and if the home sells and your name is still on title, the proceeds belong to you. The lender will then be aware of this possibility and will make sure the transfer takes place. Be proactive with this and work with your attorney closely.
The next thing you should be doing since the bankruptcy discharge is to make a plan to reestablish your credit. Lenders will make a mortgage to someone after a bankruptcy but the most important thing they look at when reviewing such a loan request is seeing if the applicant has reestablished credit. This means opening up new credit accounts, responsibly, using it and making the payments on time. Any payments that are made more than 30 days past the due date will automatically disqualify you for a conventional loan. Even just one late payment will be a problem.
You will need to establish a responsible credit history for at least two years and with at least three credit accounts for most conventional loan programs. Since a bankruptcy is a public record, other credit companies can find this out on their own. You may wonder how to get credit so soon after a bankruptcy but the answer is there are companies who specialize in providing credit cards to people who have recently experienced a bankruptcy. Many times these new credit offers ask for a security deposit of say $500 or more. Should the credit account ever go into collections, the security deposit is surrendered to the lender in addition to the outstanding balance.
Finally, your lender will want to see a stellar rental history for at least the last 12-24 months. This will be verified with a letter sent by the mortgage company to the landlord as well as copies of cancelled checks showing timely rent, both the front of the check and the back showing when the check was cleared. If there are any payments showing up as late, your application for a conventional loan will be declined.
But what all this tells you is that there is a path to homeownership and you don’t have to wait 10 years. By following these guidelines and getting your finances back on track, you won’t have to worry about having a mortgage being included as part of a bankruptcy filing.