Mortgage after bankruptcy, divorce: You need time

Low rates won't be immediately available; start rebuilding credit now


To Her Credit
To Her Credit, Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for, and also wrote for MSN Money, and, and has guested on Martha Stewart Radio and other programs. See her website for more personal finance tips and free budgeting worksheets.
Ask Sally a question, or read her previous answers in the To Her Credit archive

Dear To Her Credit,
I want to purchase a home. I have rented for the past seven years, but I owned several homes in the past. I am 52, single with grown adult children. I have worked full time as a registered nurse for the last 19 years. I have one credit card and a car loan, but my credit score is lousy as a result of divorces in 2003 and 2008 and subsequent Chapter 7 bankruptcy in 2013 after the bankruptcy filed by my ex-husband.

I see no light at the end of this dark tunnel! A mortgage broker told me that I should get one more credit card to improve. I am not sure I believe this, especially after I was suckered into a credit repair scam which did absolutely nothing for me. I have also been told by a Realtor and mortgage broker that because of my marital status it will be more difficult for me to obtain financing.

My credit score is 530. The mortgage broker who pulled my credit reports (thus another hard inquiry on my report) said that with another credit card, it will take about 12 months to get my score up to 619 so I can get mortgage preapproval.

Is every mortgage based on these credit scores, or do lenders take special cases and underwrite loans using additional information? I need help and am having trouble trusting anyone. I have saved a good down payment, I have no kids at home, and I am employed full-time in a job that pays well. I don't understand. -- Stella


Dear Stella,
You should be able to get a mortgage after bankruptcy. However, you may not qualify for the lowest rates until time has passed and your credit has been rebuilt.

Casey Fleming, author of "The Loan Guide: How to Get the Best Possible Mortgage," says, "When folks ask me if they can get a mortgage [after bankruptcy] what they usually mean is, 'Can I get a mortgage with the kind of rates I see advertised?' That answer is 'no.'"

The best mortgage rates come with "conforming loans." Those are loans that qualify to be purchased by secondary-market mortgage buyers Fannie Mae and Freddie Mac. Most banks use Fannie Mae and Freddie Mac standards to evaluate mortgage applicants. If the bankruptcy was due to financial mismanagement, Fannie and Freddie rules require you to wait four years after a Chapter 7 discharge before they will consider your loan.

The potentially good news for you is that if you have extenuating circumstances, and you document those circumstances, you may be able to meet their standards after two years. Extenuating circumstances are those that are one-time only, beyond the borrower's control, and result in a sudden, significant, prolonged loss of income. Divorce is considered an extenuating circumstance, so you'll need to produce your divorce decree and other documents to prove you deserve the "extenuating circumstances" exception.

To get an FHA-insured loan, you only need to wait two years after a Chapter 7 bankruptcy is discharged. But the FHA, unlike Fannie and Freddie, does  not consider divorce to be an extenuating circumstance, and you must have reestablished an unblemished credit history during those two years.

While Fannie, Freddie and FHA rules may allow banks to lend after two years, they don't require it. Banks may impose standards that are tougher, or looser, so expect to shop around.  

"FHA requires that a bankruptcy has been discharged for at least two years before the new loan is made if they are to issue FHA mortgage insurance. However, many -- but not all -- lenders require three years rather than two for FHA-insured loans." (In the industry, this is called an "overlay," or extension of the guidelines.) Fleming says, "These loans carry interest rates close to conforming rates, but add another 1.25 percent for FHA insurance."
Note that it's the discharge date, not the date of filing, that starts your waiting period. 

You may be able to find a lender who will make a loan sooner than under these guidelines. In fact, some lenders make loans as soon as a person's bankruptcy is discharged. "The trick, of course, is the rates and terms," says Fleming. "A borrower with a bankruptcy less than 3 years old will have to pay at least 2.5 percent more in interest than someone with good credit for equivalent terms."

Besides the bankruptcy, however, the low credit score will make getting a mortgage difficult for you. Fleming says 580 is the lowest score he's seen for halfway reasonable rates. To raise your score to that level, you'll probably want to get one more source of credit, such as a secured card where your deposit is used as your credit line. If you do that, plus keep your other card balance low and continue to pay all your bills on time, you should have a better score within four to six months.

Buying your own house is exciting and can be an important step to rebuilding your independent life after divorce. Take care of your credit, and you'll be house shopping soon.

See related: 3 quick, easy, inexpensive credit score rebuilding tools, Card tips for rebuilding credit after bankruptcy, 8 myths surrounding bankruptcy 

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Published: November 6, 2015

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