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.
A bankruptcy or foreclosure doesn’t automatically disqualify you from getting a VA loan. For the first two years following the event, it will be all but impossible. These events won’t just disappear from your credit report. And lenders will consider them as negative compensating factors that in combination with other problems can kill a loan application.
But if you commit to rebuilding your credit and making on-time payments, a VA loan can still be in your future.
There are two major types of personal bankruptcy protection — Chapter 7 and Chapter 13 —and both will crush your credit. Consumers can expect their credit scores to drop from 130 to 240 points.
That alone will 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 participate in the program 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.
Some lenders may distinguish between Chapter 7 and Chapter 13 bankruptcy when determining the waiting period for financing. This may allow someone with a Chapter 13 bankruptcy to secure financing after 12 months, but this decision is ultimately up to the lender. And that means that in a majority of the cases it will be extremely difficult for a borrower to secure financing until at least the two-year mark after a bankruptcy discharge.
It’s also important to remember that a prior bankruptcy never just disappears. If you have any slips after a bankruptcy is on your record, even if they’re only a couple late payments on small accounts, a lender may decide you’re too much of a risk and deny your loan application. A lender will also look to make sure you haven’t had a late payment in at least the previous 12 months. In the wake of a bankruptcy filing and discharge, a single late payment in that span will all but nullify your VA loan application.
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, none is quite as damaging as a bankruptcy, which can shave anywhere from 85 to 160 points from your score. Although your credit score won’t be quite as devastated, you will still be unlikely to qualify for another loan for two years and will need to work hard to rebuild your credit.
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.
Possibly compounding the issue, 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