MORTGAGE LENDING UPDATE

By David Griffin, Past President of Mortgage Bankers Association of Middle Georgia

 FHA-VA guidance on bankruptcies

Last week we discussed how a prior bankruptcy or foreclosure was viewed based upon conforming conventional (Fannie Mae or Freddie Mac) loan guidelines.   This week we’ll cover the same information, first under Veteran’s Administration (VA) and then under Federal Housing Administration (FHA) guidelines.   Bankruptcies are usually made under a Chapter 7 plan (straight liquidation or ‘clean slate’) or under a Chapter 13 (repayment) plan.

Based upon VA guidelines, the fact that a bankruptcy exists in an applicant's (or spouse's) credit history does not in itself disqualify the loan. The lender should develop complete information on the facts and circumstances of the bankruptcy. Consider the reasons for the bankruptcy and the type of bankruptcy filing. You may disregard a bankruptcy discharged more than 2 years ago. If the bankruptcy was discharged within the last 1 to 2 years, it is probably not possible to determine that the applicant or spouse is a satisfactory credit risk unless both of the following requirements are met:  The applicant or spouse has obtained consumer items on credit subsequent to the bankruptcy and has satisfactorily made the payments over a continued period, and the bankruptcy was caused by circumstances beyond the control of the applicant or spouse such as unemployment, prolonged strikes, medical bills not covered by insurance, and so on, and the circumstances are verified. Divorce is not generally viewed as beyond the control of the borrower and/or spouse. If a borrower or spouse has been discharged in bankruptcy within the past 12 months, it will not generally be possible to determine that the borrower or spouse is a satisfactory credit risk.

A Chapter 13 bankruptcy indicates an effort to pay creditors. Regular payments are made to a court-appointed trustee over a 2 to 3 year period or, in some cases, up to 5 years, to pay off scaled down or entire debts.  If the applicant has finished making all payments satisfactorily, the lender may conclude that the applicant has reestablished satisfactory credit.   If the Chapter 13 Bankruptcy is still active and the applicant has satisfactorily made at least 12 months' worth of the payments and if the Trustee or the Bankruptcy Judge approves of the new credit, the lender may give favorable consideration.

For FHA loans, a Chapter 7 bankruptcy (straight liquidation) does not disqualify a borrower from obtaining an FHA-insured mortgage if at least two years have elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have re-established good credit or chosen not to incur new credit obligations.  The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs.  

An elapsed period of less than two years, but not less than twelve months, may be acceptable 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.  Additionally, the lender must document that the borrower's current situation indicates that the events that led to the bankruptcy are not likely to recur.

 A Chapter 13 bankruptcy does not disqualify a borrower from obtaining an FHA-insured mortgage provided the lender documents that one year of the payout period under the bankruptcy has elapsed and the borrower's payment performance has been satisfactory (i.e., all required payments made on time).  In addition, the borrower must receive permission from the court to enter into the mortgage transaction.  Participation in a consumer credit counseling payment program does not disqualify a borrower from obtaining an FHA-insured mortgage,  provided the lender documents that one year of the pay-out period has elapsed under the plan and the borrower's payment performance has been satisfactory (i.e., all required payments made on time).  In addition, the borrower must receive written permission from the counseling agency to enter into the mortgage transaction.

A borrower whose previous principal residence or other real property was foreclosed, or has given a deed-in-lieu of foreclosure within the previous three years, is generally not eligible for an FHA-insured mortgage.  However, if the foreclosure was the result of documented extenuating circumstances that were beyond the control of the borrower and the borrower has re-established good credit since the foreclosure, the lender may grant an exception to the three-year requirement.  Extenuating circumstances include serious illness or death of a wage earner, but do not include the inability to sell the house because of a job transfer or relocation to another area.