Bankruptcy can do some serious harm to a credit score. On average, a bankruptcy filing can knock a credit score by more than 200 points. Someone could have a credit score of 700, fall into some financial distress, and be forced into bankruptcy and one year later the 700 turns into a 490. Creditors don’t issue a credit to someone knowing in advance the consumer will ultimately default on the credit extended nor do consumers apply for credit with no intention of making any payments. No, bankruptcies are typically the result of events outside of the borrower’s control. Common reasons for bankruptcies are an extended illness and unable to work, being laid off from a job, or the result of a contested divorce.
But bankruptcy doesn’t mean it’s the end of someone’s credit world. In fact, those who are eligible for a VA loan can discover the VA home loan program is somewhat more accommodating when it comes to bankruptcy. But then, if the VA is a bit more lenient for those who are eligible for the program, who exactly is eligible for a VA loan? Veterans are eligible and make up the largest share of VA borrowers. Active duty personnel can also qualify with at least 181 days of service as do those who have served at least six years with the National Guard or Armed Forces Reserves. Surviving spouses of those who have died while serving or as a result of a service-related injury can also apply for a VA home loan. And when any of these get into financial problems and are forced into bankruptcy, they can still use their VA home loan benefit sooner rather than later.
There are two types of bankruptcies consumers can file. A Chapter 7 bankruptcy wipes away all dischargeable debt such as consumer loans and automobile loans. Some debts aren’t dischargeable and are not affected by a bankruptcy filing. Such debts include spousal or child support payments, mechanic’s liens, property taxes and income taxes. Federal student loans cannot be discharged in a 7 filing.
A Chapter 13 bankruptcy is sometimes referred to as a “wage earners” plan because the trustee overseeing the bankruptcy establishes a repayment plan to eligible creditors that takes a portion of monthly earnings and repays the creditors on a monthly basis. A consumer must petition the court for a bankruptcy filing and the court will decide which filing fits the consumer’s current financial position. If the court determines there is no regular income that can accommodate the wage earner plan then a Chapter 7 will be allowed.
VA lending guidelines allow borrowers to apply for a VA loan just two years after the discharge of a Chapter 7 bankruptcy. During this period of time, it is critically important the veteran keep up with monthly payments on things such as utilities and other monthly obligations. Lenders also want to see the applicants reestablish credit during that two year period. This can be a bit of a challenge as potential new creditors will be rather wary of extending credit to someone with a recent bankruptcy filing. There are also other credit companies that specialize in helping consumers reestablish credit.
Once a bankruptcy has been discharged, the consumer should regularly check their credit report. Credit reports are notorious for having mistakes and it’s not uncommon for a credit line that has been discharged continue to show on a credit report as outstanding with late payments continuously accruing. After applying for a VA loan, it’s possible and sometimes likely there will be inaccuracies on the credit report as a result of the bankruptcy. In this instance, work with your loan officer to help get mistakes on your credit report corrected. Lenders have working relationships with credit reporting companies and can get mistakes fixed in as little as 24 hours compared to how long it would take a consumer to accomplish the very same. You can be expected to provide a copy of your bankruptcy papers to your lender which will show which debts were discharged.
A Chapter 13 is also an option and the veteran can even still be in a repayment plan and be eligible for a VA home loan. The trustee overseeing the repayment plan must approve the new purchase however. The court must be presented with evidence the repayment plan has been upheld with regular, on-time monthly payments in addition to having reestablished credit. With both a Chapter 7 and a Chapter 13 bankruptcy there needs to be a written, documented explanation as to the cause of the bankruptcy. Evidence of past medical bills over an extended period of time would provide proof the bankruptcy was due to an extended illness. Unemployment compensation and a letter from a previous employer showing when the employee was laid off from work proves there was very little income to repay creditors and a bankruptcy was the only option.
When there is a bankruptcy appearing in a credit history, the loan will be manually underwritten and won’t be eligible for the more efficient automated underwriting approval.
Finally, the most important thing you can do to help qualify for a VA home loan is to show a timely rental history for that two year period. This means providing copies of canceled checks made out to your landlord showing how much was paid and when. You’ll need reestablished credit accounts but timely rent carries the most weight here. With a bit of due diligence, your homeownership dreams will still come true. A bankruptcy isn’t a forever thing.