In the past decade, the American Dream of owning a home has become more like the American Nightmare. With more than 7 million homes foreclosed over the past eight years and unemployment hitting record levels, buying a house has been the last thing on people’s minds. To make matters worse, perhaps you have had to file for bankruptcy and believe that ever owning a home again is out of the question for you. That is simply not the case. In fact, the Federal Reserve Bank recently released a study revealing that consumers who dealt with their financial problems by filing for bankruptcy actually had higher credit scores sooner than those who did not file for bankruptcy. Furthermore, those who did file for bankruptcy were 70% less likely to get into foreclosure.
Are you ready to be a homeowner again? There are five steps that you should take before making the jump into a house.
A bankruptcy does stay on your credit report for up to 10 years, but you do not need to wait that long before looking to buy a house. While I have represented clients who were able to buy a home within a month after a bankruptcy case, that is more the exception than the rule. You do at least need to let the dust settle on the bankruptcy discharge papers before making that next step.
Immediately after the bankruptcy case is discharged and closed, you need to stop and take stock of where you are financially. What did you lose by going through bankruptcy? Hopefully it was mostly the burden of overdue credit and not any real assets. It is always a good idea to get a copy of your credit report both before filing for bankruptcy and after the bankruptcy discharge. That will give you a great before and after picture of your credit. Then make a practice of getting a copy of your credit report regularly after that. You’re entitled to free annual credit reports from AnnualCreditReport.com. You can also get a free credit report summary, updated every 14 days, from Credit.com.
You will need to take stock of the bills that survived bankruptcy: for example, car loans and non-dischargeable debts that must be paid. You need to understand your current budget. Know what you have coming in the door as income and what your necessary living expenses are. Take a look at expenses that are coming in the near future and some long-term goals and expenses coming four or five years down the road. Only by tightly controlling your discretionary income can you go on to the next step.
And then you need to pay every one of your bills on time, every time, all of the time. Build a rhythm of debt repayment that becomes second nature to you. If you want to use a credit card to help you rebuild credit after a bankruptcy, here are some things you need to consider.
Once you have your current budget under control, you will need to start saving money. You need to build up a nest egg not only to cover an emergency fund, but also to cover the down payment and expenses of buying a house. While Fannie Mae and Freddie Mac have just reduced the down payment requirements for their insured loans to 3% of the purchase price, conventional wisdom says that you should have about 20% of the purchase price saved for a down payment. With a 20% down payment, you will save the cost of a monthly charge for mortgage insurance premiums that protects the lender from a default on the loan. You’ll pay for it, but the lender gets the protection. That can add a few hundred dollars to your monthly payment.
There is a simple logic for a 20% investment in your home; not only does it reduce the amount you need to borrow and ultimately the size of your monthly mortgage payment, but it also represents an investment in your home that assures you won’t walk away from it when hard times come.
By saving money in excess of your expenses every month, you will get into the habit of being able to pay a mortgage or cover those unforeseen expenses of home ownership.
Owning a house is not cheap. In fact, there are some studies that show it is cheaper to rent in the short term than it is to own. In some cases, unless you intend to remain in your home for an extended period of 13 to 17 years, the return on saving the difference between rent and home ownership is huge. Remember, if something breaks when you are a tenant, you can call the landlord to come fix it. When you are the homeowner, you are responsible for fixing everything. Maintenance of a house is a big part of the money you will spend on a home.
That’s right, there is more to home ownership than just paying the mortgage every month. Besides heat and lights, you will need to supply water and sewer services, pay property taxes and insurance, landscaping (if you have a yard, even if it is only putting gas into the lawnmower), snow removal (if you are in a snow zone), possibly insect control (if you are in areas of particular infestation) and who knows what else, not to mention those small improvements you want to make to the house to make it your home. Conventional wisdom is that your housing expense (including mortgage payments) should not exceed 28% of your income. (This calculator shows you how much house you can afford.)
Since you will be locked in to a particular location for a while, you need to think about the long term. What does the career path look like? Will you need to relocate to retain your job? What does the family structure look like? The prime reason a family sells their home and relocates is to get better education for their children or to make room for the extended family as children saddled with school debt “fail to launch” or parents faced with shrinking retirements and mounting health expenses consolidate with their children to maintain a standard of living. Selling your home after only living there a short while is not a formula for success. There are expenses with selling a home that will easily eat up the down payment you paid to buy it.
There is a lot to think about when deciding to buy a house.
If your financial records are not in good shape, now is the time to start. When filing a bankruptcy, you are required to produce pay stubs covering an extended period of time, bank account records, tax returns, lists of assets and values, a budget and other documentation of your finances. While not as detailed as a bankruptcy case, similar records are required for most mortgage applications. In this electronic society, this kind of paper is still king.
Being organized with your financial records shows that you are being sensitive to the details. You know what your budget is. You know what your net worth is. You have your finger on the pulse of your money and you know that you are credit-worthy.
Coming from a bankruptcy to your fresh start means that it is unlikely you will be able to buy a house without a mortgage unless you have been extremely lucky to buy that winning lottery ticket. When applying for a mortgage, find out in advance what documents the lender will require from you and show up with them prepared to complete the application. There is nothing worse than to find the loan is delayed because you are missing a document.
Some of the things you will need for a mortgage includes a copy of your bankruptcy petition. Although the lender will draw your credit report (and you will know what is on that credit report), for some reason lenders want to see a copy of that petition. It is not enough that they can get a copy of your bankruptcy discharge or see the debts that were discharged on your credit report, they want to see the actual papers. I will submit that there is nary a banker (or non-bankruptcy lawyer) out there who can read a bankruptcy petition and understand what it means, but the requests for that paperwork is always there.
5. Shop for a Mortgage & a House
When making any large purchase, comparison shopping is paramount. You should compare the costs of things to know that you are getting the best deal. Keep in mind that you are not only shopping for a house to make your home, but you are also shopping for a mortgage to finance that purchase. More than half of all homebuyers do not shop for a mortgage.
There is more to the cost of a mortgage than the interest rate you are being charged. Many consumers fall for the trap of finding the lowest interest rate loan without looking at the whole picture. If you are coming off a recent bankruptcy, be prepared for a higher interest rate. Not that it has anything to do with risk since you cannot file bankruptcy again for a while and walking away from a home after a bankruptcy is extremely unlikely. Here’s an explainer on how mortgage interest rates work.
However, more important than a low interest rate are the upfront charges — something most consumers miss. Points (or “buy-down” charge), fees of every sort, title costs and escrow needs are very important. These charges can add thousands of dollars to the upfront cost of the loan or to the amount you may need to borrow. It may become a “pay-me-now or pay-me-later” choice; either you will need more money to close on a home purchase or you will pay more each month in your mortgage payment or both.
It used to be conventional wisdom that you should buy more house than you can afford today. The assumption was that your income and family size is likely to grow so you should spend more for a bigger house today. To some extent, this logic resulted in many families getting trapped in mortgages they could not pay, as real incomes have not grown or jobs were lost through the latest economic downturn. A bigger house costs more to heat, more to maintain and makes agents and brokers more money. Don’t get trapped by the size or cost of the house, go for the safest neighborhood and school district you can find for the buck. Then learn to be handy around the house, because repairs will be necessary no matter what.
This article was updated on March 2, 2017.