To help rebuild your financial life after bankruptcy, borrowing against some of your home’s value can be a tempting option. Home equity loans usually charge lower interest rates than personal loans or credit cards and allow you to take out larger sums. But bankruptcy’s damage to your credit score and lending history creates significant hurdles to qualifying for a new loan.
Whether you can secure a home equity loan after bankruptcy depends on your credit score, the amount of equity you hold in the property, how long ago you filed for bankruptcy and the type of bankruptcy you declared. Here’s how to increase your chances of getting approved.
Filing for Chapter 13 bankruptcy can help you catch up on missed mortgage payments and avoid foreclosure. But can you also take out a new home equity loan or tap existing home equity while in Chapter 13 bankruptcy? The answer is yes, but with some restrictions.
Getting approved for a home equity loan during Chapter 13 isn’t impossible. However, you’ll face more hurdles than borrowers with good credit and no active bankruptcy. Understanding the extra steps required will help you successfully navigate the process.
How Chapter 13 Bankruptcy Impacts Home Equity Loans
Chapter 13 bankruptcy allows you to restructure your debts into a 3-5 year repayment plan approved by the bankruptcy court. This lets you keep assets like your home, car and other property while getting rid of unsecured debts like credit cards and medical bills.
Any mortgage arrears can be folded into the Chapter 13 repayment plan. Making these payments on time helps rebuild your credit. However having an open bankruptcy will make lenders hesitant to approve new credit, including home equity loans.
Here are some of the key impacts bankruptcy will have when applying for home equity financing:
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Lower Credit Score Declaring Chapter 13 bankruptcy causes a major hit to your credit score – often over 200 points Scores below 620 will make approval very difficult
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Credit Report Damage: Bankruptcy stays on your credit report for 7 years with Chapter 13. This red flag makes lenders worry about your ability to handle more debt.
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Debt-to-Income Requirements: Lenders look closely at your income-to-debt ratios. Your bankruptcy plan payments count toward your existing monthly debts.
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Court Approval: Taking on new debt during Chapter 13 requires permission from the bankruptcy court and trustee overseeing your case.
While these factors reduce your chances, they don’t eliminate them completely. Being strategic with your application can help overcome the challenges.
When Can You Apply for a Home Equity Loan in Chapter 13?
Timing is important when seeking financing during bankruptcy. Most lenders will want to see:
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12 Months of On-Time Chapter 13 Payments: Making at least one year of on-time payments to the trustee shows you can manage the repayment plan responsibly.
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670+ Credit Score: After 12 months of payments, your credit score will likely rebound to the “fair” tier, improving your eligibility.
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50% Completion of Your Chapter 13 Plan: Being halfway through your 3-5 year commitment further demonstrates you can handle the responsibility.
Waiting until you meet these benchmarks will give you the best shot at getting approved. While technically possible earlier, you’ll have fewer options and pay much higher interest rates.
How to Get Court Approval for New Debt in Chapter 13
Before applying for a home equity loan in Chapter 13 bankruptcy, you must first get approval from the court. This requires filing a “Motion to Incur Debt”, explaining:
- The purpose of the new loan (home improvements, medical bills, etc.)
- Loan amount requested
- Proposed repayment terms
- Impact on your current Chapter 13 plan
The court will review whether the new debt fits within your repayment plan and won’t jeopardize your existing obligations. The judge must issue an order permitting you to take on the additional financial liability before any application.
Types of Home Equity Loans to Consider in Chapter 13
If granted court permission, you have three options to leverage equity in your home during Chapter 13 bankruptcy:
Home Equity Loan – This second fixed-rate mortgage lets you borrow against up to 85% of your home’s value. You receive funds in a lump sum and repay over a set term up to 30 years.
HELOC – A home equity line of credit works like a credit card, giving you access to a revolving credit line up to 85% of your home’s value. You can draw and repay funds as needed.
Cash-Out Refinance – Refinancing replaces your current mortgage with a new higher-balance loan. The funds above your old mortgage balance are paid out to you as cash.
Each has pros and cons to weigh based on your specific needs and financial circumstances in bankruptcy. Consulting an attorney can help identify the most strategic approach before filing your motion to incur debt.
Finding a Lender Willing to Work with Open Chapter 13 Bankruptcy
Qualifying criteria for home equity loans are more stringent for open Chapter 13 bankruptcy:
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Credit Score: Most lenders require at least 680. Some may go down to 640 with strong other factors.
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Debt-to-Income Ratio: Must be below 43% including Chapter 13 plan payment.
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Loan-to-Value: Maximum loan amount is lower, usually 75%-80% loan-to-value rather than 85%.
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Equity: You’ll need at least 20% equity, up to 40% with some lenders.
Because fewer lenders offer financing to borrowers in active bankruptcy, you’ll need to cast a wider net. Getting quotes from multiple companies ensures you find the best rates and terms. Online marketplaces like LendingTree allow you to easily compare offers from hundreds of lenders.
Regional banks and credit unions may also be more amenable to special circumstances than large national lenders. Working with a mortgage broker familiar with bankruptcy lending can help match you with receptive loan providers.
Alternatives If You Can’t Get Approved for Home Equity Financing
Even meeting all the benchmarks doesn’t guarantee a home equity loan approval in Chapter 13 bankruptcy. If you exhaust all options without success, alternatives like personal loans or credit cards could help bridge short-term cash needs.
However, the higher rates and fees make these a last resort. Avoid payday loans or auto title loans which charge exorbitant triple-digit interest.
For major expenses, consider saving and paying cash once your bankruptcy concludes. You’ll have many more affordable financing options after receiving your Chapter 13 discharge.
Weigh the Risks of Tapping Home Equity Before Completing Chapter 13
While you may technically qualify for a home equity loan or line of credit during Chapter 13 bankruptcy, it’s important to carefully evaluate the risks involved before taking on additional debt.
Key considerations include:
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Can you handle the higher monthly payment obligations? Defaulting could put your home at risk.
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Will interest savings outweigh added fees and closing costs? Make sure it’s cost-effective.
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Could negative home price fluctuations or lower appraisal leave you underwater on the property?
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How will it impact your existing Chapter 13 repayment plan? Ensure payments still feasible.
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Will lenders view the move favorably when ready to get a mortgage after bankruptcy? Too much debt could hurt.
Thinking through these facets will help determine if tapping equity now is prudent or better to wait until after receiving your Chapter 13 discharge. Consulting experienced bankruptcy and real estate attorneys can provide guidance based on your unique situation.
While challenging, a home equity loan during Chapter 13 isn’t impossible with proper preparation and persistence. But also consider if waiting to avoid complications may be the smarter financial decision. Analyze the costs and risks involved to make the best choice for your situation.
Work on improving your credit score
Many lenders won’t approve your application unless your credit score tops 620, though some may even refuse to work with borrowers whose scores sit below 680. To hit such targets post-bankruptcy, start by getting free copies of your credit reports from each of three credit bureaus (Experian, Equifax and TransUnion) at annualcreditreport.com. Review these for any errors that may have occurred relating to your bankruptcy or payment history. Any mistake could hurt your score, so dispute all credit report errors with the appropriate bureaus.
Next, prioritize paying all bills on time: Your payment history is the largest factor determining your score, accounting for 35% of your FICO score and 40% of your Vantage Score.
If you’ve closed many of your credit accounts when dealing with your debt and bankruptcy, you may need to open a new one to rebuild your payment history and show lenders you can responsibly manage money. A secured credit card, backed by a cash deposit, is the easiest way to do this when your credit score is low.
How bankruptcy impacts your home equity loan application
In some cases, you can maintain ownership of your primary residence despite declaring bankruptcy. However, declaring bankruptcy will negatively impact your credit score and impose restrictions on when you can borrow, making it harder to meet a home equity lender’s requirements.
Having a bankruptcy on your credit file tells lenders you were unable to meet your debt obligations and needed serious debt relief. Unsurprisingly, credit rating agencies like FICO don’t look favorably on this, since they weigh your repayment history most heavily when determining your score — so much so that you could see your credit score fall by as much as 200 points, according to credit bureau Experian.
Those with higher scores before bankruptcy will see a much bigger drop than those with lower scores who may have already had blemishes on their credit record.
How long damaging bankruptcy information stays on your credit file will depend on which kind of bankruptcy you file. Chapter 7 remains on your report for 10 years from the filing date, while Chapter 13 lingers for seven. As your bankruptcy ages, it’ll impact your score less and less, especially if you’ve responsibly used credit since.
The type of bankruptcy you file for will determine the steps you’ll need to take to keep you home. How much home equity you can shield varies widely depending on the state you live in and its homestead exemption rules.
Chapter 7 bankruptcy: Also known as liquidation bankruptcy, you’ll sell your assets to pay off a portion of your debts. The remaining balance is eliminated when the bankruptcy is discharged, typically within a few months. You’ll need to pass a means test to use this option.If you file Chapter 7 and want to keep your home, you must be current on your mortgage payments and complete a bankruptcy exemption to shield all your home equity from creditors.
Chapter 13 bankruptcy: With Chapter 13 (also known as repayment bankruptcy), the debt is restructured around a three-to-five-year payment plan, so that monthly bills become more manageable and some or all of your debt gets cleared in that time. Any remaining balance will be canceled when the bankruptcy is discharged.
If you’re behind on your mortgage payments, you can include this in your three-to-five-year repayment plan and maintain home ownership. The repayment plan can also help protect any home equity that isn’t covered by a bankruptcy exemption.
How a Chapter 13 Bankruptcy Can Wipe Out A Home Equity Line of Credit
FAQ
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