Bankruptcy Shouldn’t Make You Less Creditworthy

The Federal Housing Administration will allow a bankruptcy debtor to get a mortgage backed by FHA in as little as one year after bankruptcy – if certain minimal criteria are met.

The one year timeframe also applies to short sales and even foreclosures

This is yet another acknowledgment that the “stigma” of bankruptcy has been replaced by the “necessity” of bankruptcy.

FHA Recognizes Bankruptcy Shouldn’t Make You Less Creditworthy

In a letter to lenders dated August 16, 2013, FHA Commissioner Carol Galante states

As a result of the recent recession many borrowers who experienced unemployment or other severe reductions in income, were unable to make their monthly mortgage payments, and ultimately lost their homes to a pre-foreclosure sale, deed-in-lieu, or foreclosure. Some borrowers were forced to file for bankruptcy to discharge or restructure their debts. Because of these recent recession-related periods of financial difficulty, borrowers’ credit has been negatively affected. FHA recognizes the hardships faced by these borrowers, and realizes that their credit histories may not fully reflect their true ability or propensity to repay a mortgage.

The FHA will consider borrowers who have received a bankruptcy discharge or short sale or foreclosure more that one year prior if the borrower experienced an Economic Event and can document the following:

  • Prior to the economic event, the borrower had good credit and that certain credit impairments were the result of a Loss of Employment or a significant loss of Household Income beyond the borrower’s control;
  • The borrower has demonstrated full recovery from the event; and
  • The borrower has completed housing counseling.

Filing Bankruptcy Is An Economic Event

The FHA defines an Economic Event as “any occurrence beyond the borrower’s control that results in Loss of Employment, Loss of Income, or a combination of both, which causes a reduction in the borrower’s Household Income of twenty (20) percent or more for a period of at least six (6) months.”

There seems to be an enormous gap in the definition, though. This definition does not take into account a borrower who becomes sick or disabled or who must care for a relative who becomes sick or disabled but who does not experience a decrease in income. So, the definition should be expanded to include borrowers who experienced an increase in expenses equal to twenty (20) percent or more for a period of at least six (6) months. But for now, this is a start.

Clearly, FHA’s new policy is reflective of today’s economic reality.

As Americans start to come out of their foxhole and reenter this battered economy, they find themselves straddled with accumulated debt and massive negative equity in real estate – be it their home or investment properties.

In order to fully recover, many Americans are turning to bankruptcy to get a fresh start. The FHAunderstands this, and seems ready to help people get a mortgage after bankruptcy.