Distressed homeowners may file for bankruptcy protection. Some want to keep their houses, others seek to have their mortgage debt discharged in the bankruptcy. Sometimes months or even years later the house is foreclosed upon. That's a lot of serious financial consideration swirling around, and each puzzle piece can have a significant impact on your ability to secure a VA home loan.
Let's take a closer look at having a mortgage discharged in a Chapter 7 bankruptcy and what that can mean for VA loan prequalification.
A mortgage is a secured debt, which means it's backed by collateral, in this case your house. A Chapter 7 bankruptcy can eliminate your personal financial liability for the mortgage. It basically wipes away what you owe on the home. But a Chapter 7 bankruptcy discharge doesn't eliminate the lien on the property. That gives the lender the ability to foreclose on the property and seek to recoup at least some of their investment.
VA borrowers will typically need to wait two years from the date of their Chapter 7 bankruptcy discharge to pursue a VA home loan. That date marks when the consumer is no longer legally responsible for the mortgage debt -- and that, it turns out, is a significant distinction.
The reason is that it's not uncommon for a home to be foreclosed on after a bankruptcy. Foreclosure comes with its own "seasoning period," typically at least two years for VA loans, during which you likely won't be able to secure home financing.
Needless to say, it's this one-two punch that leads to a ton of confusion, not just among homebuyers but even attorneys and lenders themselves.
Veterans who complete a foreclosure, deed-in-lieu of foreclosure or a short sale in conjunction with a bankruptcy will have a two-year waiting period before they can obtain a new VA-backed loan. At Veterans United, when that waiting period starts is based on the latest date of either the bankruptcy discharge or the transfer of the home's title.
The good news is there's only one two-year waiting period. Veterans don't get hit twice with separate seasoning periods for both the bankruptcy and the foreclosure.
When there's a foreclosure, deed-in-lieu or short sale wrapped up with a bankruptcy, these events often happen close to the same time. But significant delays do sometimes arise between the Chapter 7 bankruptcy discharge and the transfer of title. Veterans in those situations will want to talk with their loan officer in more detail.
Some homeowners seek to hold onto their homes during the Chapter 7 bankruptcy process. This is known as a "reaffirmation," and it means you're still on the hook for the mortgage debt and regular monthly payments. This debt won't be wiped as part of the bankruptcy discharge. There are arguments for and against doing this, and they're all beyond the scope of this post. Definitely talk with a good bankruptcy attorney in your area if you're considering reaffirming your mortgage.
If you don't reaffirm the mortgage, then your legal responsibility for the mortgage debt ends with the bankruptcy discharge. But it is possible to continue living in the home after the bankruptcy in some cases. Lenders might decide it's better to keep getting mortgage payments rather than go through the time and expense of formal foreclosure proceedings.
In terms of getting a new VA loan, lenders are going to take a detailed look at cases like this. You may need to be able to show a history of continued on-time mortgage payments or that you have permission from the bank to live there rent-free.
Lenders evaluate these kinds of scenarios on a case-by-base basis.
Homeowners can't fully discharge mortgage debt in a Chapter 13 bankruptcy.
Lenders may want to see that you've made on-time mortgage payments for at least the last 12 months. Would-be buyers who walk away from their homes or otherwise stop making mortgage payments may be in a tough spot. Lenders will typically initiate foreclosure proceedings in cases like these, which means you'd need to wait at least two years from the foreclosure sale date to be eligible for another VA loan.
Foreclosure can still have a big effect on your buying power if your home was backed with a VA mortgage. The VA loan entitlement utilized on that mortgage would effectively be unavailable, and, at that point, you'd be relying on your second-tier entitlement to purchase again without a down payment.
In addition, both bankruptcy and foreclosure can do serious harm to your credit profile. How much of a hit your score takes depends on a number of factors, including what kind of overall credit profile you have. For example, a consumer with a high credit score could take a 240-point hit after a bankruptcy and a 120-point hit after a foreclosure, according to FICO.
Working to repair your credit during any two-year seasoning period is critical. You can talk with a credit expert in our Lighthouse program at 888-392-7421. They work with veterans, service members and military families for free to develop a plan to boost their credit scores and get on the path to loan prequalification.