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Refinancing During Chapter 13 Bankruptcy

Refinancing During Chapter 13 Bankruptcy

While going through chapter 13 bankruptcy, it can be a challenge to get your finances back on track. If you have an existing mortgage you’d like to refinance, it can be even more challenging to find mortgage companies that will refinance your mortgage.

While it is possible to refinance your home during a chapter 13 bankruptcy, you will have to meet additional lender refinance criteria.

Here’s everything you need to know about refinancing during chapter 13 bankruptcy.

What is Chapter 13 Bankruptcy?

One of the most common types of personal bankruptcy in the United States is chapter 13 bankruptcy.

During chapter 13 bankruptcy, outstanding debt is repaid via a consolidated payment plan over a 3-5 year period. Outstanding debt is discharged after completion of the repayment waiting period.

Mortgage Refinance Options During Chapter 13 Bankruptcy

Lenders look more favorably upon chapter 13 bankruptcy compared to chapter 7 bankruptcy. This is because chapter 13 shows your effort to repay all or some of the debt, as opposed to wiping out the debt via liquidation of assets.

Conforming guidelines require you to wait two years following a chapter 13 discharge and four years following a chapter 7 discharge before becoming eligible for financing.

Federal Housing Authority (FHA) and Veterans Affairs (VA) guidelines, however, are less stringent. In fact, both offers refinance options to borrowers currently undergoing a chapter 13 bankruptcy in certain circumstances.

Keep in mind, FHA loans are only available on primary property transactions and VA loans are limited to eligible veterans.

Mortgage Refinance Criteria During Chapter 13 Bankruptcy

Both FHA and VA guidelines are more difficult to qualify for while undergoing chapter 13 bankruptcy than a standard refinance. Lenders want to see you have righted past financial missteps and are on the path toward solid financial footing.

The following conditions must be met in order to refinance:

  • At least 12 months’ worth of payments must have been made per the bankruptcy repayment plan
  • A minimum credit score of at least 580 (depending on the loan program)
  • You must verify the bankruptcy was a result of a significant, one-time economic event and that steps have been taken to avoid a similar event in the future
  • You must obtain permission from the Trustee or Bankruptcy Judge to proceed with the refinance

The good news is that lenders can work with your attorney directly to facilitate refinance court approval. Typically, the lender sends a copy of the preliminary refinance terms to the bankruptcy attorney for review and submission to the court.

Depending on volume, court approval turnaround times can take weeks or even months. Once the court approves the refinance, the lender will proceed with closing.

Benefits to Refinancing

Refinancing can be an excellent option if you are able to satisfy the criteria above. If refinance rates have dropped since the time of purchase, a rate and term refinance will help you take advantage of lower interest rates. This will also result in a lower monthly payment.

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With an FHA loan, you can refinance your loan balance up to 96.5% of the property’s value on a rate and term refinance.

A cash-out refinance can also benefit borrowers during chapter 13 bankruptcy. You can use the cash to pay some, or all, of their consolidated debts. The FHA allows cash-out refinances up to 80% of the property value.

You also must have occupied the subject property as their primary residence for at least 12 months to qualify for an FHA cash-out refinance.

Mortgage Refinance Considerations

There are some drawbacks with refinancing during bankruptcy to consider as well.

Credit Impact

Declaring chapter 13 bankruptcy has a negative impact on your credit report, meaning you won’t have access to the best rates. Sometimes it’s best to wait until the bankruptcy has been discharged. This gives credit time to recover for a lower rate.

In addition, there are closing costs associated with a refinance.

Closing Costs

These include title and escrow fees, appraisal fees, notary fees, etc. For cash-strapped borrowers, coming in with funds to close for a refinance can be difficult.

It is possible to roll funds to close into the refinance loan amount to lower or eliminate the closing costs. Lenders can also offer ‘no cost’ refinances with a lender credit to cover non-recurring closing costs.

You would still need to come in with funds to cover costs incurred regardless of refinancing such as prepaid interest and impounds.

Additional details on these options are available here.

The Mortgage Refinance Process

Aside from the criteria noted above, a chapter 13 bankruptcy refinance follows the standard refinance process.

Meet Requirements To Lock In Your Rate

You need to satisfy certain debt-to-income ratio (DTI) and property equity criteria. To do so, you will provide income and credit documents up front, such as paystubs, W2s, and bank statements.

Prepare For A Home Appraisal

An appraisal will be ordered to confirm property value and borrower equity. FHA and VA appraisals are slightly more stringent than conforming appraisals.

Details on FHA appraisals are noted here; including items for you to watch out for prior to inspection.

The Bottom Line

Once the appraisal is complete, underwriting approval obtained, and court sign-off secured, the refinance is ready for closing!

While refinancing during a chapter 13 bankruptcy involves more hoops to jump through than a standard refinance, it can be an excellent option if you are able to satisfy the additional mortgage lender criteria.

Are you interested in refinancing your home after filing for chapter 13 bankruptcy? Getting pre-approved is the first step to determining your options.

We can get started on your pre-approval today! You can also give us a call at (855) 855-4491.

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