If you’ve been through bankruptcy, you may feel more cautious than ever about taking out new loans – especially on your home. But if you’re careful and well informed, refinancing can help you save money and unlock the equity in your home at a low-interest rate.
What Are the Reasons To Refinance After Bankruptcy?
There are several ways that refinancing can help you save money or improve your financial situation.
Lower your interest rate
Lowering your interest rate by 1% or more can save you hundreds every month. Just think, that’s money you can use to pay down your debts, create an emergency account and stabilize your finances for the future.
Get rid of mortgage insurance
If you either took out a conventional loan and paid less than 20% down or you took out a Federal Housing Administration (FHA) loan, you’re probably paying a monthly mortgage insurance fee.
Refinancing may allow you to lower your monthly mortgage insurance payments or get rid of them.
Get a fixed interest rate
If you have an adjustable-rate mortgage, don’t forget that your monthly payments will increase after your introductory rate ends. Refinancing may help you lower your monthly mortgage payments and stay ahead of future interest rate increases.
A fixed interest rate can give you a greater sense of financial stability. Your monthly mortgage payments will stay the same for the life of the loan. And that can help make your long-term budgeting easier and improve your financial situation.
Take cash out
If you’ve been making your monthly mortgage payments and your home has increased in value, you may be able to take advantage of your existing home equity with a cash-out refinance.
A cash-out refinance lets you borrow against your home’s equity at lower interest rates than most home equity loans.
What Are the Challenges to Refinancing After Bankruptcy?
Before you decide to refinance, you’ll need to take into consideration that bankruptcy does add some challenges to the refinancing process.
Finding a lender
You don’t have to hide your bankruptcy from your lender. In fact, you can’t hide it, and you should consider targeting your lender search. Look for lenders who have worked with borrowers who have gone through bankruptcy.
Getting a favorable interest rate
After bankruptcy, your credit score will take a major hit. And the lower your credit score, the less likely you are to get approved for a mortgage.
Even if you can get approved, you may not qualify for the best interest rates the lender has to offer. Higher interest rates will raise the overall costs of your loan and negate any financial benefit you hoped to gain from refinancing.
To give yourself the best chance to qualify for a lower interest rate, work on improving your credit score and debt-to-income (DTI) ratio during that window of time between your bankruptcy discharge and when you apply for a refinance.
Providing your lender with documentation
You’ll also need to work a little harder to provide your lender with all the documentation they’ll need to understand your financial situation. This may include writing a letter of explanation that details the reason(s) for your bankruptcy and what you’re currently doing to turn things around.
Negotiating closing costs
When you close on a mortgage refinance, you have to pay closing costs (usually 3% – 6% of the loan’s value). A portion of these closing costs often includes origination fees (loan processing fees) and other fees charged by the lender.
While lenders may be willing to show some leeway with these fees, they may have less incentive to waive the fees because of the extra scrutiny your application may require. It’s highly unlikely that all of your closing costs will be waived by the lender.
How Long Will I Need To Wait To Refinance After Bankruptcy?
Your wait will depend on the type of bankruptcy you filed for and whether the type of loan you plan to refinance with is a conventional loan or a government-backed loan.
Waiting periods after a bankruptcy discharge are:
|Chapter 7||Chapter 13|
|Conventional Loan||4 years||2 – 4 years|
|FHA Loan||1 – 2 years||0 – 2 years|
|Department of Veterans Affairs (VA) Loan||2 years||1 year|
|U.S. Department of Agriculture (USDA) Loan||3 years||1 year|
Chapter 7 bankruptcy
With a Chapter 7 bankruptcy, you and your attorney file a petition with the court that states that you can’t pay off some of your debts. Some of your personal assets will be sold off by a bankruptcy trustee to pay off your eligible debts. After 90 – 100 days, your bankruptcy is discharged. And that means that your creditors can’t continue to try to collect.
Still, you won’t be 100% off the “debt hook.” You’ll still have to pay back some types of debt, like student loans, child support and other court-ordered judgments. Your bankruptcy will stay on your credit report for up to 10 years.
Chapter 13 bankruptcy
A Chapter 13 bankruptcy is a much longer process, but you get to keep more of your property.
After reviewing your financial situation, a bankruptcy court will work with your creditors to come up with a repayment plan. The plan will restructure a portion of your debt and consolidate your payments into one monthly payment that you’ll make to a bankruptcy trustee over the next 3 – 5 years. (You’ll still be responsible for student loans and other debts that weren’t eligible for the repayment plan.)
At the end of the repayment plan, your bankruptcy gets discharged. Your credit score takes a smaller hit, and the bankruptcy will stay on your credit report for up to 7 years.
As you can see from our table, it’s easier to refinance after a Chapter 13 bankruptcy than it is to refinance after a Chapter 7 bankruptcy. A Chapter 7 bankruptcy can label you as a higher-risk borrower to lenders because of your past problems paying off debts.
How Do You Refinance Your Mortgage After Bankruptcy?
There are challenges that come with refinancing after bankruptcy, but once you’ve been through the waiting period, and you’re ready to refinance, it’s the same application process you’d go through for any kind of mortgage refinance.
- Look for a lender
- Submit your application and any supporting documents requested by the lender
- Select a lender based on the terms they offer you
- Go through the underwriting process (your finances are reviewed in greater detail during this part)
- Get your home appraised so the lender has a sense of its fair market value (this may be optional depending on the type of refi)
- Close on the refinance
How To Save if You Can’t Refinance
If you can’t refinance your mortgage, talk to your lender about a mortgage recast or a mortgage modification.
If you’re expecting to get a large sum of money in the future – and using it won’t divert funds from paying down your debts or meeting your bankruptcy obligations – you can ask your current lender about a mortgage recast.
With a mortgage recast, you make one large payment toward your mortgage balance. In return, your lender agrees to lower your payments or cancel your private mortgage insurance (PMI).
Take note: This only applies to conventional mortgages – and your lender may not offer a mortgage recast option.
If you’re falling behind on your payments or you’re worried that you’re at risk of foreclosing and losing your home, you may be able to negotiate a mortgage modification with your lender.
With a mortgage modification, your lender agrees to:
- Extend your mortgage repayment period
- Lower your principal balance or interest rate
- Add your past due amount back into your mortgage and recalculate a new monthly mortgage payment
There are loan modification programs available for conventional mortgages that are backed by Fannie Mae and Freddie Mac. There are also FHA and VA loan modification programs available. Make sure and talk to your lender to see if you qualify.
Refinancing for Your Future
Refinancing your home after bankruptcy can be challenging. But with a little planning, you can take advantage of your home loan to get your money matters back on track – and leave your bankruptcy in the past.
Fannie Mae. “B3-5.3-07, Significant Derogatory Credit Events — Waiting Periods and Re-establishing Credit.” Retrieved September 2021 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-3-Traditional-Credit-History/1032994681/B3-5-3-07-Significant-Derogatory-Credit-Events-Waiting-Periods-and-Re-establishing-Credit-08-07-2019.htm
U.S. Department of Housing and Urban Development. “Section C. Borrower Credit Analysis Overview.” Retrieved September 2021 from https://www.hud.gov/sites/documents/4155-1_4_SECC.PDF
U.S. Department of Veterans Affairs. “VA Pamphlet 26-7, Revised Chapter 4: Credit Underwriting 4-1V.” Retrieved September 2021 from https://www.benefits.va.gov/WARMS/docs/admin26/pamphlet/pam26_7/ch04.pdf
U.S. Department of Agriculture. “Chapter 10: Credit Analysis.” Retrieved September 2021 from https://www.rd.usda.gov/files/3555-1chapter10.pdf