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.
Mortgage Discharged in Bankruptcy
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 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. (Some lenders, including Veterans United, won’t have a seasoning period for short sales in most cases.)
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.
When Foreclosure Follows a Bankruptcy Discharge
It can take banks years to foreclose on a property. The fear is that a veteran may be just a few months from the end of their two-year seasoning period only to have their old property get foreclosed upon, kicking off a new two-year wait.
That isn’t what happens on a VA loan, at least here at Veterans United. Again, our concern is when you were no longer legally responsible for the debt. If the answer is the Chapter 7 bankruptcy discharge, then a subsequent foreclosure doesn’t “double hit” the veteran with a new 24-month waiting period. You’re not going to get penalized twice.
The only potential wrinkle here is if your foreclosure occurs on an FHA loan. Default or delinquency on federal debt can be a major problem for VA approved lenders. If the government files a foreclosure claim, then you may need to wait three years from that date, regardless of the bankruptcy discharge.
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.
Making Mortgage Payments After Bankruptcy
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 won’t be wiped as a part of the 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. Continuing to live in the home after that point can raise concerns unless you’re still making payments or you have permission from the bank to live there rent-free. In general, lenders will look at your recent rental or homeownership history to verify you’ve made on-time housing payments for at least 12 consecutive months.
Chapter 13 Bankruptcies
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.
Rebuilding Your Credit
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.