Bankruptcy and Access to Future Credit
Bankruptcy clients are always concerned about how a bankruptcy filing affects their credit history and ability to obtain new credit. One of the most frequent issues is whether bankruptcy will disqualify the debtor when trying to buy a home in the future. This question is particularly pertinent for clients considering whether to try to remain in a current home where the payments have become very burdensome. Sometimes the best long-term strategy is to walk away and start over as part of the debtor's fresh start.
You may qualify to purchase a home as early as one year after filing Chapter 13 (while the plan is still being funded), or one year after discharge in Chapter 7, depending upon the circumstances. The more customary period is two years. Whether you can qualify for FHA or VA loan guarantees may be a determining factor in your ability to obtain a home loan.
FHA will insure mortgages to individuals who have filed Chapter 7 liquidation bankruptcy two years after the discharge if "the borrower has re-established good credit (or has chosen not to incur new credit obligations), and has demonstrated an ability to manage financial affairs."
To obtain a loan within one year after the discharge, the borrower must show that "the bankruptcy was caused by extenuating circumstances beyond his or her control and has since exhibited an ability to manage financial affairs and the borrower's current situation is such that the events leading to the bankruptcy are not likely to recur."
FHA will consider approving a borrower who is still paying on a Chapter 13 Bankruptcy if those payments have been satisfactorily made and verified for a period of one year. The Chapter 13 trustee’s written approval is required in order to proceed with the loan. You will have to give a full explanation of the bankruptcy with the loan application and must also have re-established good credit, qualify financially and have good job stability.
FHA insured mortgages are generally not available to borrowers whose property was foreclosed on or given a deed-in-lieu of foreclosure within the previous three years. If the foreclosure was the result of extenuating circumstances, however, an exception may be granted if you have since established good credit. This does not include the inability to sell a home when transferring from one area to another.
VA has similar regulations:
- If the bankruptcy was discharged more than 2 years ago, it may be disregarded
- If the bankruptcy was discharged within the last 1 to 2 years, it is probably not possible to determine that you and/or your spouse are a satisfactory credit risk unless both of the following requirements are met:
- you and/or your spouse have reestablished satisfactory credit, and
- the bankruptcy was caused by circumstances beyond your and/or your spouses control (such as unemployment, medical bills, etc.)
- If the bankruptcy was discharged within the past 12 months, it will not generally be possible to determine that you and/or your spouse are satisfactory credit risks.
VA regulations allow granting of the loan guarantee to a person in a Chapter 13 when the plan payments are finished satisfactorily, or after 12 months payments and the trustee or the court approves of the new credit.
If you obtain home loan financing with a loan guarantee, the loan rate should be based on the guarantee status of the loan. As a result, the interest rate should not be significantly affected by the bankruptcy.
Cleaning up Your Credit Report
The fact that you filed a bankruptcy will stay on your credit report for up to 10 years after the date of last action in the bankruptcy case. Credit bureaus, however, often show debts you discharged in a bankruptcy on your credit report. If your credit report does not show the fact that you received a discharge in bankruptcy, notify the credit bureau in writing that you received a discharge, giving them the details and a copy of it. Within 30 days, that discharge should show on your credit report.
If Debts You Discharged Appear on Your Credit Report
A recent decision in the U.S. District court for the Central District of California gives Experian, Equifax and TransUnion until October 1, 2008 to properly show discharge of debt in bankruptcy, and the discharged status of a debt that was discharged, on your credit report. Discharged debts should NOT show up as late or active or overdue. Those debts should be reported as "discharged". If this decision is not appealed, you may see your credit report reporting discharged debts correctly. If you see a discharged debt reported any other way, you should notify the credit bureau in writing.
You Want Discharged Debt Reported Correctly on Your Credit Report
If you don't owe a debt, you want that reflected on your credit report, because unpaid debt pulls down your credit score. You filed bankruptcy to get a fresh start, and it is not fair for them to report debts you discharged as active. That practice has led to the practice of collectors buying "zombie debt" and trying to guilt trip you into paying it to get it off. You need not do that. Simply notify the credit bureau to report discharged debt as discharged, and you will improve your post-bankruptcy credit score!
Bankruptcy and Student Loans
Since 2005 there is no distinction between the dischargeability in bankruptcy of private vs government-backed student loans. To discharge a student loan in bankruptcy, most courts use the test set forth in what is called the "Brunner" case. It involves 3 steps. You must prove (1) if forced to repay the student loans, you would be unable to maintain even a minimum standard of living; (2) this situation will continue for all or most of the student loan repayment period; and (3) you have made good faith efforts to repay the student loans.
Many debtors can prove elements 1 and 3. Proving the second prone, that your current financial situation is going to continue for a prolonged period can be tough. Also, many courts add a requirement that you show a "certainty of hopelessness" and prove that there is really no possible way that you could ever repay the loans. A very high standard in deed.
Adding insult to injury, student loan creditors are aggressively arguing in bankruptcy courts that there are other repayment alternatives available that a debtor should try before seeking to discharge the debt in bankruptcy, such as "income based repayment" or IBR, which is at least available on federal loans.
On private loans, one may be able to negotiate settlements with some creditors to reduce the balance due. If it does not appear that you can discharge the loans in bankruptcy, you may wish to try to resolve the loans through a settlement of some kind.