Buying a Home in California After Bankruptcy: Basic Mortgage Rules

Home buyers in California who have been through a bankruptcy within the past few years sometimes have a harder time qualifying for mortgage loans.

Bankruptcy filings like Chapter 7 and Chapter 13 can significantly lower a person’s credit score. They can also stay on your credit reports for years, raising a red flag with banks and lenders.

But there’s still hope! In fact, you might be able to get a mortgage loan sooner than you think.

Getting a Mortgage in California After Bankruptcy

All of the major mortgage programs allow home buyers with previous bankruptcies to qualify for financing, after a certain “waiting period” has passed.

You could further support your cause by reestablishing a pattern of timely payments and limiting your use of credit going forward. Both of those things could help you qualify for a home loan in California after a personal bankruptcy filing.

The specific rules and requirements can vary depending on what type of home loan you’re using. In this guide, we will focus on the post-bankruptcy mortgage requirements for the two most popular types of home loans in California:

• FHA loan requirements, according to the Federal Housing Administration
• Conventional loan requirements, according to Fannie Mae and Freddie Mac

Let’s start with FHA loans, since they tend to be the most forgiving when it comes to buying a home after a bankruptcy event.

FHA Loans Are Generally the Most Forgiving

FHA loans are a kind of government-backed mortgage loan. The Federal Housing Administration provides insurance to lenders that gives them financial protection from borrower default.

This is important, because the rules for using an FHA loan after a Chapter 7 or Chapter 13 bankruptcy come from the federal government in this case. And the requirements can differ depending on what type of filing you have.

When using an FHA loan, it’s possible to buy a home in California within one to two years after a bankruptcy filing. Here’s an overview of the specific rules contained in the official HUD handbook:

• Chapter 7: A person typically has to wait at least two years from the bankruptcy discharge date to qualify for an FHA loan. You also have to reestablish good credit during that time. If a Chapter 7 bankruptcy was brought on by extenuating circumstances beyond your control, the waiting period might be reduced to one year.
• Chapter 13: If you have a Chapter 13 bankruptcy, you could potentially qualify for an FHA loan in California within one year. You’ll need to make on-time payments within your payment plan, and you might need permission from the bankruptcy court to take on a mortgage debt.

For those who don’t know, the main difference between Chapter 7 and Chapter 13 bankruptcy filings has to do with how debts are handled and whether assets are kept or liquidated.
Chapter 7 involves liquidating nonexempt assets to pay off creditors, while Chapter 13 involves a court-structured repayment plan over 3-5 years.

Fannie Mae’s Requirements for Conventional Loans

Fannie Mae is one of the two government-sponsored enterprises (GSEs) that purchase home loans from lenders and sell them through the secondary mortgage market. Freddie Mac is the other one.

A lot of conventional (non-government-backed) mortgage loans originated in California end up being sold to either Fannie or Freddie. So lenders have to follow certain rules and requirements if they want to sell their loans through the GSEs.

Here are Fannie Mae’s general requirements for borrowers with bankruptcies:

If it’s a Chapter 7 or 11 bankruptcy filing, a person generally has to wait at least four years from the discharge or dismissal. This can be reduced to two years if there are extenuating circumstances.

With a Chapter 13 filing, a borrower could be eligible for a mortgage loan two years after the discharge date, or four years after a dismissal. A borrower might qualify two years after the dismissal if they can document extenuating circumstances.

Freddie Mac’s Two-Year Rule

Freddie Mac (the other GSE and mortgage buyer) has a two-year rule for most California home buyers who’ve had a bankruptcy filing. But unlike Fannie Mae, they don’t make a clear distinction between Chapter 7 versus Chapter 13 filings.

According to Freddie Mac’s guide for mortgage lenders, all bankruptcy actions require a waiting period of “24 months from the discharge or dismissal date.”

They also require mortgage lenders to gather some extra documents for the mortgage file. This can include a copy of the bankruptcy petition, the schedule of debts and discharge or dismissal, and evidence that shows all relevant debts have been paid or are being paid.

Borrowers must also be able to demonstrate that they have “reestablished and maintained an acceptable credit reputation,” according to Freddie Mac. A lender can determine this by looking at credit reports and scores, primarily.

About Those ‘Extenuating Circumstances’

The official bankruptcy rules for both Fannie Mae and FHA allow for “extenuating circumstances” when qualifying for a mortgage after a bankruptcy. This refers to events beyond the borrower’s control that have negatively impacted their financial situation.

Examples of extenuating circumstances include:

• Unexpected loss of employment due to layoffs, company closures, or industry downturns.
• Significant medical expenses due to illness or injury, especially if uninsured or underinsured.
• Loss of income or increased financial burden due to the end of a marriage or death of a spouse.
• Major damage or loss of property due to natural disasters like fires, floods, or earthquakes.

These are just a few examples. The specific circumstances can vary depending on the type of mortgage loan being used. Borrowers need to provide documentation to support their claims of extenuating circumstances (a termination letter from an employer, copies of medical bills, etc.).

Alternative Financing Options Are Available

In addition to conventional and FHA loans, California home buyers might have other financing options to facilitate a post-bankruptcy home purchase. These could include the following.

Portfolio loans: Some lenders keep a portfolio of loans that they don’t sell to the secondary market. These loan products might have more flexible underwriting guidelines and may be a good option for borrowers with unique financial situations, including past bankruptcies.

Non-Qualified (Non-QM) mortgage loans: Designed for borrowers who don’t meet the traditional lending standards. They often have higher interest rates but offer more flexibility in terms of credit history and income verification.

Hard money loans: Typically used for short-term real estate transactions and are based on the value of the property rather than the borrower’s creditworthiness. Hard money loans can be a viable option for borrowers with poor credit, but they often come with higher rates and fees.

The Bottom Line for Borrowers

A bankruptcy filing is not a life sentence. It’s possible to qualify for a mortgage loan to buy a home in California after a Chapter 7 or Chapter 13 bankruptcy, as long as you reestablish of pattern of responsible payments.

Depending on the details of your filing and the type of loan you use, you might have to wait anywhere from one to four years. But it’s do-able.