We’ve all been there before –when life takes an unexpected turn. Things don’t go the way we were hoping. We lose our job, suffer a pay cut, or get flooded with unexpected debt from medical bills or other unforeseen expenses. No one sets out expecting to file bankruptcy, but it happens. In fact, recent studies have shown that two-thirds of bankruptcies are due to unforeseen medical bills. Can you get a FHA loan after your file chapter 7?
Chapter 7 bankruptcy, otherwise known as liquidation bankruptcy, is the process of selling off assets to pay off, discharge, or clear all or some of your debts. While the main benefit of filing chapter 7 is to give you a fresh start –it isn’t a silver bullet, and it’s not guaranteed to solve your every financial woe. However, for those who have found themselves beneath a mountain of debt, with no way to dig out, chapter 7 could prove to be a viable option.
Fortunately, after chapter 7, there is still hope. Given time, and hard work, you can rebuild your credit. Eventually, buying a home might even be in your future, and after taking careful steps, you could even become eligible for an FHA loan.
If homeownership is something that you’d like to see in your future, here’s a look at the requirements for an FHA loan –an option that many first-time buyers opt for. Read on to see how you can work to build up your credit and get yourself financially ready.
What Is an FHA Loan?
The reason for this loan’s popularity is that it makes it much easier for mid-to-lower income buyers to get on the housing ladder. An FHA loan could allow you to take out a mortgage with a lower down payment and a lower credit score. With this type of loan, the interest rates are often slightly lower as well, although you will have to pay mortgage insurance (MIP) fees.
FHA loans are offered by lenders and insured by the Federal Housing Association (FHA). This means that even if the borrower stops making payments, the government will repay a portion of the loan. This makes it possible for those with damaged credit to get a loan and increases your chances of being approved for one by minimizing the lender's risk.
Current FHA loan down payment requirements
The down payment amount required for an FHA loan will depend on your credit score.
Currently, a credit score of at least 500 will require a 10% down payment, while a credit score of 580 or above makes you eligible for a 3.5% down payment.
It’s important to note, however, that with an FHA loan you will be required to pay mortgage insurance. Conventional loans require this as well, but making a higher down payment –of at least 20% eliminates the need for this insurance. With an FHA loan, however, this insurance is required regardless of the down payment.
Applying for an FHA Loan After Bankruptcy
The good news is that you can apply for an FHA loan, even after filing chapter 7.
Generally, a borrower will need to be two years out of bankruptcy and have re-established good credit before they can be approved for an FHA loan. It’s important to note that this refers to two years after the discharge date, not the date that the bankruptcy was filed.
However, there are exceptions to this two-year rule. If you have been out of bankruptcy for over one year and can prove that there were extenuating circumstances that caused the bankruptcy –that is, things that were beyond your control, you may be able to apply for this loan. This could include a job loss, significant reduction in pay, or medical condition. You must show that these circumstances caused a six-month loss of income of at least 20%. You’ll also need to show that you had a good payment history before and after this event.
You will also have to prove that you can manage your money in a responsible manner.
Additionally, you’ll want to make sure you’re financially stable –and able to keep up with the mortgage repayments.
Other requirements include the repayment of any tax liens to the IRS, or agreement to a repayment plan with the IRS. Additionally, any judgments against you will need to have been paid as well.
Of course, just because you apply, doesn’t mean that you are guaranteed approval for an FHA loan. There are steps that will need to be taken in first, to get yourself into the strongest position possible to borrow.
Here are a few things that you can do to help get yourself ready:
During this period of time, you’ll need to have steady employment, re-established credit, and 12 months of on-time rental payments. If you’re self-employed, you’ll need proof of income in the form of business tax returns and financial statements.
You’ll also want to keep in mind that when buying a home, there will be a number of expenses that you’ll be responsible for paying. This includes fees such as loan origination fees, attorney fees, and appraisal costs. In some cases, with an FHA mortgage, the seller or lender may be able to pay some of these costs for you, however, it’s a good idea to have enough saved up to cover these costs, just in case. You’ll also need to save up for the down payment, and sock away enough cash to give you some reserves.
When you apply for an FHA loan, you will still need to come up with a down payment. You’ll need 3.5% if your credit score is 580 or higher.
Closing costs will vary depending on your lender and location, but in most cases, you can expect to pay anywhere from 2-7% of your home’s value in closing costs. Closing costs include loan origination fees, appraisal fees, title searches, title insurance, surveys, taxes, deed-recording fees.
Other expenses property taxes and homeowner’s insurance. Mortgage insurance will be included in your mortgage costs, while other ongoing expenses will also include maintenance and repairs.
Finally, FHA loans require that you have enough cash reserves to cover at least one month’s mortgage payment –this is in addition to your down payment and closing costs.
Starting the process of saving money now can help you down the road when you apply for your FHA loan and increase your chances of being approved.
Improve Your Credit Score
When applying for an FHA loan, you’ll also want to work to improve your credit score. Anytime you apply for bankruptcy, your credit is going to take a hit. While this can be difficult to rebuild, it isn’t impossible. Here are a few things that you can do to improve your credit score.
Consider Opening a Secured Card
Opening another credit card after a bankruptcy can be challenging, considering that the credit card companies will look at your credit score to determine if you qualify. One way to re-establish good credit is to apply for what’s known as a secured card. With a secured card, you open up the card using a security deposit that will serve as a small line of credit. The company keeps the money as collateral, and you use the card as you normally would. However, it is extremely important that you use this card responsibly. If you don’t make your payments on time, you can lose your deposit. You’ll also want to make sure you don’t close down the card too early, as this could also negatively impact your credit score.
Make Payments On Time
Making on-time payments is one of the best ways to establish your credit. Your payment history accounts for 35% of your credit score –so make sure you make your payments on time, every time. Set reminders, enroll in auto payment, whatever it takes to ensure you aren’t past due. You may also want to look into overdraft protection, a service that’s offered by many banks. With this option, your bank will pay out even when funds aren’t available. This can help to give you a buffer, should you forget about an upcoming charge.
Keep Balances Low
You need to establish credit by having credit –but you should work to keep your balances low. A lower balance can help to improve your credit score. Don’t charge more than you can pay off in one month, and always aim to keep your balances paid in full. In most cases, you should aim to keep your card balances below 15% of their limits.
Keep New Accounts to a Minimum
Opening too many new accounts in a short period of time can actually harm your credit score. While it’s necessary to open a few accounts in order to reestablish yourself, you should be sure to keep the number of new accounts you open to a minimum.
Applying for an FHA Loan
To apply for an FHA loan, you’ll need to go through an FHA-approved lender. Many banks can offer FHA loans, and it’s a good idea to secure quotes from at least three different lenders, to find the best deal on the mortgage loan. All FHA loans include closing costs and other fees, which vary considerably, so be sure to have a look to see what’s available before going with one bank. See: best lenders for FHA loans.
While an FHA loan isn’t for everyone, for many first-time buyers, it can prove to be a great way to get on the housing ladder. In most cases, you’ll want to work hard to get your credit score up above 580 to get the best loan terms possible and make sure you have enough savings before you apply. You’ll also want to make sure you’re in a place where you’ll be able to afford the mortgage repayments, along with any other associated expenses, before applying for one.
Are you planning to apply for an FHA loan? Let us know.
Please Note: The information in this article is intended to inform and to guide only, and it is not meant to serve in place of counsel from a licensed attorney. We recommend consulting with an attorney and a financial advisor before pursuing bankruptcy, or for help restructuring your finances following a bankruptcy