July 21, 2017

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FHA Loan Rules For Bankruptcy: Chapter 7 and Chapter 13

We’ve had a number of reader questions in our comments section recently asking about scenarios for loan approval that involve bankruptcy and related issues. Can a borrower get a new FHA loan following a bankruptcy? Under what conditions?

FHA loan rules in HUD 4000.1 address this issue with separate entries for Chapter 7 and Chapter 13. According to the FHA loan rule book, Chapter 7 requires the lender to observe the following:

“A Chapter 7 bankruptcy (liquidation) does not disqualify a Borrower from obtaining an FHA-insured Mortgage if, at the time of case number assignment, at least two years have elapsed since the date of the bankruptcy discharge. During this time, the Borrower must have:

– re-established good credit; or
– chosen not to incur new credit obligations.”

HUD 4000.1 also mentions that a waiting period less than two years may be possible depending on circumstances. “An elapsed period of less than two years, but not less than 12 months, may be acceptable, if the Borrower can show that the bankruptcy was caused by extenuating circumstances beyond the Borrowers control and has since exhibited a documented ability to manage their financial affairs in a responsible manner.”

So in the case of Chapter 7, the borrower’s credit activity is just as important as the reasons for the original Chapter 7 filing in the first place.

For Chapter 13, there are more complex issues at stake including whether or not the court will permit the borrower to enter into a new financial obligation. From HUD 4000.1:

“A Chapter 13 bankruptcy does not disqualify a Borrower from obtaining an FHA- insured Mortgage, if at the time of case number assignment at least 12 months of the pay-out period under the bankruptcy has elapsed. The Mortgagee must determine that during this time, the Borrowers payment performance has been satisfactory and all required payments have been made on time; and the Borrower has received written permission from bankruptcy court to enter into the mortgage transaction.”

Court permission is an area the FHA cannot address beyond what is mentioned above, so borrowers dealing with a Chapter 13 will need to discuss the matter with their participating lender to see what has typically happened in the past in such circumstances, any applicable state law, etc.

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