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One of the most touching experiences loan officers go through when we conduct marketing campaigns seeking FHA mortgage prospects are the borrowers who call us wanting to buy a home for their family but they just have too much bad credit to overcome in order to qualify for even an FHA loan. Often they have a bankruptcy.

First, here are FHA’s guidelines regarding bankruptcy:

E. Bankruptcy. A Chapter 7 bankruptcy (liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have reestablished good credit or chosen not to incur new credit obligations.

The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. An elapsed period of less than two years, but not less than 12 months, may be acceptable if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his or her control and has since exhibited a documented ability to manage his or her financial affairs in a responsible manner.

Additionally, the lender must document that the borrower’s current situation indicates that the events that led to the bankruptcy are not likely to recur.

A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA-insured 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.

If your borrower has a bankruptcy that is less than 2 years but more than 12 months old and you want to try for the “extenuating circumstances” provision, keep in mind that many extenuating circumstances which would be acceptable to explain a few late payments will not be good enough to avoid waiting 2 years after a bankruptcy. The extenuating circumstance here must truly be a catastrophic experience, such as the death of a primary wage earner. It also cannot be a situation where the borrower filed a bankruptcy over a small amount of debt that the underwriter might feel they should have toughed out and paid.

Some lenders actually have stricter requirements and will look into the details of the bankruptcy. For instance, even if the time required has already passed but it looks like the bankruptcy was filed over a relatively small amount of debt which the borrower could have paid off with a little sacrifice the lender may require an automated approval before granting the mortgage. Of course, some lenders are much more lenient than others. In your own mind, just use common sense to make sure you are dealing with a borrower who really has gotten over their problem and is unlikely to repeat it.

Over in the Active Rain Real Estate Network, Bob Mitchell with ValueList Real Estate Services, Inc. in St. Louis, MO has an excellent post on his blog with tips on how to recover after a bankruptcy entitled “Help, I’ve Fallen And I Can’t Get Up!” – Rebuilding Credit After A Bankruptcy“. I encourage you to take a look at it so you can give a little help to those borrowers who can’t fit the FHA guidelines yet.

By the way, if you are not familiar with the Active Rain Network, it is a wonderful resource for information on real estate and mortgages and also to meet others in the field. If you would like to join, please click on my link above so I’ll get credit for the referral. There’s no money in it, but it enhances my reputation in the community there to get a lot of referrals. ;)


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Filed under: FHA guidelines • HUD Regulations • Industry Information

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