This post is written both for those contemplating a Chapter 13 (repayment plan) bankruptcy as well as for those currently in a Chapter 13 Plan. A Mortgage refinance or a home purchase, while still in a Chapter 13 bankruptcy, is possible; it is also a complicated financial and, legal transaction. To do this requires a highly specialized mortgage professional experienced with both FHA lending rules and Chapter 13 bankruptcy as well as local court rules. Such an individual must know how the Chapter 13 Trustee in your Federal Bankruptcy District deals with this process. It is helpful if your attorney respects the reputation of your mortgage professional.
The Chapter 13 Payment
One of the most important things to understand is how important on-time Chapter 13 Payments are to the mortgage underwriting process. I strongly encourage you to read this: The Chapter 13 Payment. Your Chapter 13 Trustee payment is given the exact consideration as your mortgage payment by the rules of mortgage underwriting. From the underwriting perspective, one thirty-day late payment of either the mortgage or Chapter 13 Trustee payment will sink your prospects of getting mortgage loan approval. Mail your payment early or set your on-line bill pay or direct payment to the Trustee so that you always know your payment has had time to get to the Trustee’s office and be posted by the staff at that office. Too many times, on review of the Chapter 13 Payment history, we find a payment was posted on the 2nd day of the month. One day counts as a late payment. Your experienced mortgage lender can help you check your Chapter 13 payment history in real time.
Mortgage Choices for Chapter 13 Debtors (purchase or refinance)
The only mortgages available, either for refinance or purchase, for those in a Chapter 13 Plan are those which are insured or guaranteed by the Federal government. These mortgages are either: insured by FHA or guaranteed by VA or, the USDA.
While there are distinct differences within these three programs, they are alike in their Chapter 13 Bankruptcy underwriting guidelines*. A significant factor is that the only choice is a 30-year fixed rate mortgage priced at the current market rate. To be clear, there are no conventional mortgages available for potential borrowers. One should understand sub-prime mortgages have not been available in the US since 2008. For additional information regarding adverse credit events timelines and mortgage timeout rules click here.
There are now non-Qualified Residential Mortgages (QRM) which may allow a borrower to purchase or refinance once the Chapter 13 case has been Closed following the Discharge. The rate in this type of loan is higher than any other mortgage product available. The costs are also higher.
How does a bankruptcy affect a borrower’s eligibility for an FHA mortgage? A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA mortgage provided the lender documents that one year of the payout period under the bankruptcy has elapsed and the borrower’s payment performance has been satisfactory (i.e., all required payments made on time). In addition, the borrower must receive permission from the court to enter into the mortgage transaction. The exception is that most underwriters will consider the Chapter 13 Trustee’s approval as acceptable permission from the court.
What are some of the factors that will keep you from getting approved?
If there are still balances showing as unpaid on your credit report, even if the debts are listed in your bankruptcy, the debt will need to be paid OR the underwriter will need proof that the base of your Plan will be paid off with the refinance. If there are balances showing and you are unable to pay-off the base of your Plan, you may be unable to refinance until after you receive your Discharge and the case has been closed.
If a second mortgage is being stripped or crammed down in your Plan, the Chapter 13 must be Discharged and the deed removed from the property or the mortgage servicer must agree to a subordination. If there are judgment liens against the property which are being stripped from the property, your bankruptcy must be Discharged. Depending on how the Plan is written this can be simultaneous if the Title Insurance company legal department understands Chapter 13 with a Strip on Discharge.
The Application to Incur New Debt
To get underwriting approval for a Chapter 13 Debtor to refinance, the Chapter 13 Trustee (Colorado) or Court must approve your application to incur new debt. Talk with your attorney to determine how and when to best proceed, or not. This is a process which you can only do with the assistance of your attorney. Your attorney must prepare the financial statements to submit to the Trustee in order for authority to be granted for a lender to offer new credit. Your mortgage loan originator should be able to assist your attorney in completing the Application to Incur New Debt. If your mortgage loan originator does not know how to prepare such, you should find someone with more experience to help minimize your legal costs.
This is a Great Time to Refinance
Now is, without a doubt, continues to the best time in over sixty years to purchase a home or, refinance a home loan. As this is written fixed rate 30 year FHA mortgages are still at historic lows. For those with an Adjustable Rate, Option ARM or a Balloon Mortgage this is an excellent time to refinance. This process typically will take planning and action prior to refinancing. This is not a run of the mill refinance and not every mortgage lender is qualified to do this complex transaction.
Mortgage Refinance After Chapter 13 Discharge?
Yes, one may refinance after the bankruptcy case has been Discharged the Court and then Closed by the Trustee. However, because of the new rules for virtually all mortgage financing in the USA, once the Chapter 13 Plan has been successfully completed and Discharged, getting a mortgage refinance can be difficult. This is because a manual underwrite is mandated* and few lenders are willing to take the risk of not having the safe harbor provided by the Qualified Residential Mortgage rules. Begin reestablishing good credit while your case is still open so by the time your Discharge enters, you have solidly reestablished good credit. There are numerous posts in my blog on rebuilding credit, even while in Chapter 13.
Preliminary Requirements for Purchase or Refinance While in Chapter 13
- Twenty-four months of current housing payments with no 30-day late payments and, the likelihood of the income continuing for at least three years.
- Two years IRS Returns showing your income is sufficient to pay the mortgage as well as your Chapter 13 payment and any debt not included in the bankruptcy payment.
- Minimum middle FICO Score of 680 . Most will need to practice what I’ve previously posted as FICO 101a, 101b and 101c for several months prior to making a successful application for mortgage credit.
- For anyone with a fear of having credit make time to read both Credit: Use It to Build It (Part 1) and Credit: Use It to Build It (Part 2).
- Begin rebuilding your credit as soon as your Chapter 13 Plan is Confirmed/Court Approved; this is when your property has been revested to you.
- The maximum no-cash out loan to value on an FHA appraisal is presently 95% – Refinance.
- The minimum down payment is 3.5% of the purchase contract or appraised value whichever is less. – Purchase
- The maximum Debt to Income Ratio is 42.99% and this is pushing the envelope to the extreme.While in Chapter 13, it is mandatory to have Court approval (in Colorado, generally the Trustee approval suffices) to obtain a mortgage, go to this URL FHA Handbook 4000.1 II.A. 5.a.iii (H)(2)(3).
- There is more detail to this process but this is the essence of purchasing or refinancing while in Chapter 13.
There is more detail to this process than can reasonably be discussed herein but this is the essence of purchasing or refinancing while in Chapter 13.Bankruptcy Seal image attribution Model T image attribution Financially Speaking™ James Spray, RMLO, CNE, FICO Pro CO LMO 100008715 | NMLS 257365 | November 1, 2010 – Revised May 20, 2017 Notice: The information on this blog is opinion and information. While I have made every effort to link accurate and complete information, I cannot guarantee it is correct. Please seek legal assistance to make certain your legal interpretation and decisions are correct. This information is not legal advice and is for guidance only. You may use this information in whole and not in part providing you give full attribution to James Spray.