Bankruptcy and foreclosure have become increasingly common in the rough economic stretch of the past few years.
These are tough financial decisions that can significantly affect a consumer’s credit score and overall fiscal health. But veterans and active duty military members, it’s important to know that a bankruptcy or foreclosure doesn’t mean you have to forget purchasing a home with your VA entitlement.
If you’re worried about your credit, Veterans United’s Lighthouse program can help you get on the right track, and you can apply for a VA home loan right now.
A bankruptcy or foreclosure doesn’t automatically disqualify you from getting a VA loan. But you’ll typically need to wait two years from a bankruptcy or foreclosure before being able to qualify for one. There are exceptions in some cases, such as a Chapter 13 bankruptcy or a short sale.
Let’s take a closer look.
There are two major types of personal bankruptcy protection — Chapter 7 and Chapter 13 —and both can crush your credit. Consumers may see their credit scores drop anywhere from 130 to 240 points following a bankruptcy, depending on the type, the borrower’s financial profile and other factors, according to research from credit scoring firm FICO.
The credit score drop alone can make qualifying for a VA loan incredibly difficult, but lenders also require borrowers to be a “satisfactory credit risk.” VA-approved lenders want to see that prospective borrowers can return to a solid financial footing over a two-year period.
The VA has some exceptions that allow military members to be eligible before that two-year mark. But, remember that VA-approved lenders, and not the VA, ultimately issue the loan. They have more stringent standards that rise above the VA home loan requirements.
But the wait may be just one year following a Chapter 13 bankruptcy. Veterans and service members who file Chapter 13 protection may be able to obtain a VA home loan just 12 months removed from their filing date. They’ll need to get approval from their bankruptcy trustee among other requirements.
Foreclosure can take several forms: foreclosure, short sale or a deed-in-lieu of foreclosure.
Foreclosure is when the bank takes back your house through formal proceedings because you can’t make the payments. A short sale is when the lender allows an underwater homeowner to sell the home for less than what is owed in order to recover at least some of the cost.
A deed-in-lieu allows a homeowner to return the house to the lender without formal foreclosure proceedings. None are particularly beneficial outcomes for borrowers, and all can prove more problematic for military buyers.
In terms of a credit crunch, a foreclosure or its relatives could knock anywhere from 85 to 160 points from your score, according to FICO. In addition, you’ll typically need to wait two years from the foreclosure in order to pursue a VA loan. There are a couple exceptions, one of which is good and the other not as much.
First, the good: Some lenders, including Veterans United, don’t have a “seasoning period” following a short sale in most cases. That means borrowers who meet the credit, income and other requirements for any VA purchase loan could look to buy again right after a short sale. Requirements will vary by lender.
Second, the bad: You might face a longer wait — three years — if you defaulted on an FHA loan.
We also dedicate an entirely separate article to covering what can happen when you experience both a bankruptcy and a foreclosure, which isn’t uncommon. You can read that here.
Countless service members have been told they could never again qualify for a VA loan if they had a previous VA loan foreclosed upon. That’s simply false. A unique concept called second-tier entitlement can help veterans in this situation once they’re beyond that two-year window.
Each of these financial events can be devastating, but they don’t determine your future. Mistakes and tough times in the past can put homeownership out of reach for a time. But if you’re committed to rebuilding your financial profile and meeting all obligations moving forward, the VA home loan program may still be a viable vehicle for a home purchase.
Photo courtesy Jeff Turner