How Lenders View Reasons for a Bankruptcy Filing

Written by Posted On Thursday, 25 March 2021 00:00

It’s really not a secret that getting a mortgage after a bankruptcy, be it a Chapter 7 or 13 filing, can happen. Different loan programs have different guidelines with most programs asking for a four year waiting period while re-establishing credit. Yet lenders aren’t obligated to issue a new home loan just because the waiting period has been passed. If a mortgage was included in the bankruptcy, it becomes even more difficult. And remember, just because program guidelines allow for someone to apply and get a new mortgage doesn’t mean the individual lender will follow those guidelines. A lender can require even more requirements, often referred to as ‘overlays’ that mean the borrower must jump through a few more hoops. One of the more important aspects is what drove the potential borrowers into bankruptcy in the first place.

Many who faced foreclosure or a bankruptcy did so because of poor money management. Someone who gets a first credit card might see a brand new road ahead with a new automobile loan or installment loan. When a first credit account is opened, some unfortunately look at other credit opportunities. Someone with zero monthly credit obligations who gets a first credit card might suddenly add several other credit accounts, knowing that they are in fact credit-worthy in the creditor’s eyes. This can be a dangerous path with multiple accounts being opened in a relatively short period of time. New accounts mean new credit inquiries showing up on a credit report. New monthly debt along with multiple new queries will drive credit scores down to a level where a mortgage will be a bit more difficult in which to qualify.

When a mortgage lender looks at a loan application where there was a bankruptcy involved, the lender will want an explanation letter from the applicant explaining the circumstances involved. The bankruptcy papers will list the various accounts included in the bankruptcy and will match up with a credit report. The lender can easily tell whether or not credit was handled responsibly or not. In this instance, it wasn’t.

On the other hand, a bankruptcy can be filed due to circumstances beyond the borrower’s control. For example, a couple bought a home together and opened up some credit accounts including a couple of credit cards and two automobile loans. Yet later on, the marriage went south, and the couple gets a divorce. The divorce decree will list who is responsible for which payments. If credit becomes an issue, it’s usually because a spouse can’t pay the bills without the other spouse’s income. In this instance, a lender will look at a filing more favorably than someone who doesn’t manage money very well.

Another example is a loss of job, leading to reduced monthly income. Medical emergencies can also be a contributor to a bankruptcy filing. Someone who has a car accident and in the hospital for a couple of weeks will typically mean the individual cannot return to their previous job due to the injuries. Again, a lender understands how this can happen.

Remember, it’s not an automatic that someone can get a mortgage when a certain period of time has passed. With a bankruptcy, the lender will want to know what caused the event.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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