I am almost two full years from my Chapter 13 bankruptcy discharge. The value of my home has recovered that I am looking to refinance. Can I qualify for a conventional mortgage or am I limited to an FHA mortgage?

By Michael Jensen, Mortgage and Finance Guru

Edited by Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience

Updated November 10, 2021

Lenders impose waiting periods after negative credit events such as a bankruptcy before you can apply for a mortgage. The waiting period following a Chapter 13 bankruptcy is two years for a conventional mortgage and one year or less for an FHA, VA or USDA mortgage (in some cases you can qualify for these programs before your bankruptcy is discharged if you meet certain requirements).

The applicable waiting period starts from the date your bankruptcy is discharged. After the two year waiting period expires you are eligible to apply for a conventional mortgage with a traditional lender such as a bank, mortgage broker or credit union.

There is a difference, however, between applying for a mortgage and qualifying. Your ability to qualify for a mortgage depends on many factors including your debt-to-income ratio, employment history and especially your credit score. Unfortunately, a bankruptcy can have a significant negative impact on your credit score which can make qualifying for a mortgage more challenging.

A Chapter 13 bankruptcy stays on your credit report for seven years and can cause your credit score to drop approximately 130 to 200-plus points, depending on what your score was prior to the bankruptcy and the terms of your bankruptcy plan. The lower your credit score, the more difficult it is to qualify for a mortgage and the higher your mortgage rate. Additionally, a higher mortgage rate increases your monthly payment and reduces the mortgage amount you qualify for.

Depending on how the bankruptcy affected your credit score and how much your score has recovered since your bankruptcy was discharged, you may not meet the minimum score required for a conventional mortgage, which is approximately 640 for most loan programs.

This is a worst case scenario and as long as you followed the terms of your bankruptcy plan, made your monthly debt payments on-time and took prudent steps to rebuild your credit, your score should gradually recover over time and hopefully position you to qualify for a mortgage.

Additionally, if you continued to pay your mortgage or repaid your entire loan balance and your home did not go into foreclosure, this can be beneficial when you apply for a mortgage in the future. If you also experienced a default, short sale or foreclosure, additional waiting periods may apply before you can qualify for a mortgage.

Review Waiting Periods Following Negative Credit Events Before You Can Apply for a Mortgage

So the answer to your question depends on your current credit score and the overall shape of your credit profile. We recommend that you use a credit score monitoring website to determine your current score before you apply for a mortgage. While the scores provided by these free services are usually different than the FICO scores used by mortgage lenders, they are directionally accurate and can help you track your progress.

If your current credit score is high enough to qualify for a conventional mortgage, then move forward with the application process. The table below shows conventional mortgage rates and fees for leading lenders in your area. We recommend that you shop multiple lenders as mortgage terms vary, especially for applicants who have experienced a negative credit event such as a bankruptcy.

If you determine that your credit score does not meet the requirement for a conventional loan, you should consider an FHA mortgage, which requires a credit score of 580 if you make a down payment between 3.5% and 10% of the property purchase price and a score of only 500 if you make a down payment of at least 10%. This is why the FHA mortgage program is helpful for credit-challenged borrowers.

Review our FHA Mortgage Guide

The downside of an FHA mortgage is that you are required to pay an upfront and ongoing FHA mortgage insurance premium (MIP). You are required to pay the FHA MIP regardless of what your loan-to-value (LTV) ratio is at the time you get your mortgage. If your LTV ratio is less than 90% at the time your loan closes, however, you are only required to pay the monthly FHA MIP for the first eleven years of your mortgage.  In comparison, for a conventional mortgage, as long as your loan-to-value ratio (LTV) is below 80% at closing, you are not be required to pay private mortgage insurance (PMI).

Offsetting this extra monthly cost, FHA mortgage rates tend to be 0.250% to .750% lower than conventional loan rates. This is because the FHA mortgage program is insured by the federal government so there is less risk for lenders. The table below outlines FHA mortgage rates and fees, including the upfront MIP. We always recommend that you contact multiple lenders to find the best loan terms. Shopping for your mortgage is the best way to save money on your loan.

In sum, your financing options depend on your credit score and other mortgage qualification factors. If your score has recovered sufficiently following your bankruptcy, you may be able to qualify for a conventional mortgage. Otherwise, an FHA loan may be your best financing alternative.

Sources

"B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit."  Selling Guide: Fannie Mae Single Family.  Fannie Mae, August 7 2019.  Web.

"II.A.4.b.iii. Evaluating Credit History (TOTAL)."  FHA Single Family Housing Policy Handbook 4000.1.  Federal Housing Administration, January 2 2020.  Web.