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Reader question: “My son’s bankruptcy discharge is less than 2 years old. I believe his credit score is slightly less than 620. I am willing to co-sign for a home for him. I carry a very good credit rating. Is this even possible with FHA?”

Let me start with the disclaimer that I’m not a mortgage lender. Only an FHA-approved lender can tell your son whether or not he is qualified for the program.

You didn’t mention whether it was a Chapter 7 or Chapter 13 bankruptcy filing. The rules are a bit different, depending on the type of filing. So I’ll just cover both of them, for the benefit of all readers.

Qualifying for FHA After Chapter 7 Bankruptcy

It is the Department of Housing and Urban Development (HUD) that establishes the guidelines for Federal Housing Administration loans. Current HUD guidelines state that borrowers may be eligible for an FHA loan two years after a Chapter 7 bankruptcy discharge date, as long as they have re-established a pattern of good credit.

I refer to this as “time and good behavior.” There is a time component, but that’s not the only requirement. The borrower must also avoid any other credit problems during the two-year period — that’s the “good behavior” component. If any negative entries (late payments and such) have appeared on the credit report within the two years following bankruptcy, it could derail the borrower’s chance of getting an FHA loan.

Keep in mind that mortgage lenders can, and often do, impose their own guidelines on top of those set by HUD / FHA. These are known as “overlays,” in lender jargon. Credit scores are a good example. HUD sets the minimum credit-score cutoff at 500 for program eligibility. But most lenders require scores of 600 or higher, making HUD’s minimum something of a moot point. This can happen with FHA loans and bankruptcy as well. Some lenders require borrowers to wait at least three years after bankruptcy, before they’ll approve them for FHA financing. This is another example of an overlay.

From what I can gather, lenders are being more cautious / conservative with their lending guidelines these days. So a higher percentage of them might be leaning toward a three-year rule, as opposed to only two years. But don’t take my word on this. At the two-year point, your son might want to start applying. In fact, it wouldn’t hurt to speak to a lender now, just to see where they fall on this issue.

There is an exception to the above rule. According to HUD, a borrower who has filed Chapter 7 may be eligible for the FHA program in as little as one year, if…

“the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his or her control and has since exhibited a documented ability to manage his or her financial affairs in a responsible manner.”

Note: The above quote, and all of the other rules regarding bankruptcy, come from HUD Handbook 4155.1, Chapter 4, Section C, entitled “Borrower Credit Analysis.”

Chapter 13 Filings

The rules are less restrictive for Chapter 13 bankruptcy. For those who don’t know, the primary difference between Chapter 7 and Chapter 13 filings has to do with the repayment of debts owed. With a Chapter 13 filing, most of the debts owed are discharged by the court. In Chapter 7, the person filing for bankruptcy agrees to a court-approved repayment plan, in order to repay the debts over time.

Current guidelines state that a borrower may be eligible for an FHA loan one year after a Chapter 13 bankruptcy, if all debt payments have been made as ordered by the court. In other words, if the person adheres to the repayment plan, he or she could qualify for an FHA-insured loan within one year of the discharge date.

Clean Credit Report is Key to Approval

I can’t stress the importance of the credit report enough. When a borrower applies for an FHA loan after a bankruptcy filing, the lender will want to know how well (or how poorly) they’ve been managing their financing since the bankruptcy was discharged. They do this by checking the borrower’s credit report, among other things. If any late payments, missed payments, charge-offs or debt collections were reported in the months after the filing, it will harm the borrower’s chance of getting approved.

For more information on these and other credit-analysis rules, see the following section of the HUD handbook.

Reference: HUD Handbook 4155.1, Chapter 4, Section C