If you’re one of the millions of Americans who have declared bankruptcy, home ownership can seem like a pipe dream. But don’t give up—it is possible to own a home after bankruptcy. In fact, according to a study by the Federal Reserve Bank of New York, consumers who were struggling financially recovered more quickly when they filed for bankruptcy, rather than deal with their many debts. However, it’s important to take the right steps to make home ownership a reality.
If you’re ready to be a homeowner, here are five steps to help you buy a house after bankruptcy.
1. Reorganize Your Finances
Once some of your debts are discharged in bankruptcy, you’ll be on the road to recovery. But don’t rush out to get a home just yet—wait for the dust to settle and get your finances in order.
Examine Your Debts and Credit Report
Take stock of where you are financially now that a few of your debts have been discharged. Bankruptcy isn’t something anyone wants, but for people in dire financial trouble, it can be the only way to wipe out liabilities and get a fresh start. Bankruptcy will actually reduce financial stress so you can focus on making positive financial decisions.
Next, get a copy of your credit report. If you have a copy of your report prior to filing for bankruptcy, use that to create a before-and-after picture of your finances. Make it a regular practice to review your credit so you can look for any mistakes and get them corrected. It’s also encouraging to see the progress you’re making over time.
Put a Budget Together
Take control of your monthly household budget so you can pay every one of your bills on time, every time. Figure out your monthly income and expenses so you know what you have room for—or what you don’t. Anticipate upcoming annual costs, like taxes or car registration, and put money aside so you aren’t scrambling to scrape up the funds when these costs are due.
Consider a Credit Card
You can also start building your credit by using a credit card to pay some of your monthly bills. If you choose to do this, make sure you use the credit card like cash and pay it off every month. If you keep a close eye on your budget, pay all bills on time, and monitor your credit report, you’ll start to see positive change that will get you closer to buying a house.
2. Grow Your Savings
You’ve probably heard the adage “pay yourself first.” If you want to buy a house after bankruptcy, this is one of the most important things you can do. Now that you’ve refamiliarized yourself with your finances, it’s time to start saving.
Figure Out How Much You Can Save
One of the positive side effects of bankruptcy is that you’ll have the breathing room to start putting away a little bit of money every paycheck. And it doesn’t matter how little that amount is. It’s helpful to get into the habit of saving—even if you can spare only $5 every two weeks. Of course, the more money you can save, the better. But start saving no matter how much you can contribute.
An easy way to develop the habit of saving—and putting money towards a down payment—is to use a “forced savings” method. With this method, the money is put into savings before you even see it. There are apps that can help with this, but the most common technique is to schedule an automatic deduction from your paycheck or checking account that transfers directly into a savings account.
Set an Objective
After you determine how much you can squirrel away each month, set a goal amount for your future home’s down payment. It’s recommended to put down 20% of the overall purchase price when you buy a new home. Although you can get some home loans with a smaller down payment, 20% saves you money on mortgage insurance and your monthly payment. It also gives you some instant equity in your new investment.
3. Make a Plan
There’s more to homeownership than signing on the dotted line and paying the mortgage every month. For example, as the homeowner, you’re responsible for any surprises that come up, which can be anything from a clogged drain to a new roof. Extra expenses like these are part of the homeownership package.
Calculate What You Can Afford
In addition to saving up for a down payment, you should also adjust your monthly spending to account for the overall cost of maintaining a home. Conventional wisdom is that you shouldn’t spend more than 28% of your income on housing expenses—including the mortgage payment. Before you set your heart on that darling Craftsman house, use this online calculator to find out exactly how much home you can afford.
Schedule an Inspection
When you’re shopping for a home, make sure you get a thorough inspection to help you identify any potential problems that’ll need to be fixed within the first few years. If you don’t think you’d be able to afford those repairs, consider moving on to a different house. You don’t want to fall into big credit card debt because of a surprise furnace replacement.
Consider Additional Costs and Factors
On top of big home repairs, you should also prepare for regular maintenance, such as landscaping, pest control, and snow removal. Depending on your location, you may also need extra insurance for floods or earthquakes.
It’s also important to like the neighborhood you’re moving into. Many people end up looking for a new home within a couple years because they didn’t think about things like the quality of local schools or the crime rate. If you’re looking for long-term home, make sure you’ll be comfortable with your new neighborhood and neighbors.
4. Organize Your Financial Documentation
Because you went through a bankruptcy, you know what it’s like to compile months—or even years—of pay stubs, account statements, tax returns, lists of assets, and other financial documentation. While buying a home isn’t as rigorous as going through bankruptcy, many of the same records are required for most mortgage applications.
If you know you want to buy a home, you should start keeping meticulous financial records right now. Having organized financial records shows that you are sensitive to the details. If you have a finger on the pulse of your finances, you’ll know what your budget is, what your net worth is, and when you are creditworthy for a home.
Unfortunately, even in an electronic world, paper is still king when it comes to mortgage approval. You will need to keep both electronic and paper records. Have a copy of your bankruptcy petition ready, and add it to your credit report and bankruptcy discharge documentation. An easy way to get your financial documents organized is to split them into different categories, like the following:
- Bank, credit card, and loan statements
- Investments—such as savings bonds, retirement accounts, and stocks
- Tax records
- Insurance documents
- Legal documents—like your bankruptcy petition and marriage or divorce records
- Employment records—including pay stubs
- Medical bills—especially if you’ve had large medical expenses
As you get closer to making a home purchase, find out in advance what documents the lender will require and make sure you have everything in place. A missing document can delay closing on the loan and cost you extra money.
5. Shop Around for Mortgages
Buying a house is one of the biggest purchases you’ll ever make, so it pays to compare lenders when you’re ready to take the plunge. Many people overlook shopping for the best mortgage because it’s more fun to shop for your dream house. Don’t make that mistake.
There’s more to the cost of a mortgage than the interest rate. You need to look at the whole picture to make sure you’re getting the best deal for your financial situation. If you’re coming off a recent bankruptcy, you should also expect a higher interest rate right out of the gate.
Determine Which Loan Type You Need
Consider what type of loan is best for you. Conventional loans are offered by private lenders like mortgage companies, credit unions, and commercial banks. These loans tend to have more rigid criteria for approval but offer more flexibility after the loan is secured. Government loans are also available.
The best-known government loan is the FHA loan, which is backed by the Federal Housing Administration (FHA). These loans usually have more flexible income and down payment requirements. However, FHA loans often restrict your ability to rent out or flip the property because these loans are intended for first-time or low-income home buyers who are expected to make the house their primary residence.
Know Your Interest Rate Options
When it comes to the nature of financing, you can get either a fixed-rate or an adjustable-rate mortgage. With a fixed rate, you are locked into the interest rate available at the time you sign your loan documents. This lets you have a predictable mortgage payment, but you’d have to refinance if you ever wanted a lower rate. Adjustable-rate mortgages fluctuate with the market, which means you could end up with a much larger monthly payment than you started out with.
Don’t Forget about Additional Fees and Expenses
Fees for appraisals, inspections, title processing, and escrow needs can pile up fast. These fees will either be added to your up-front expenses or rolled into your loan. If combined with your loan, these costs will impact your monthly payment and the total interest you pay over the lifetime of the loan.
Because you’re getting a mortgage after bankruptcy, make sure the terms and extra fees make sense for your financial situation and future goals. You’ve worked hard to rebuild your credit so you can buy a home, and you don’t want to end up drowning under an interest rate or heap of fees that you can’t comfortably afford.
There is life—and home ownership—after bankruptcy. You’ve been given a chance to build a new financial future. Start with a clear understanding of where your credit stands. Then learn about credit repair and use the five steps listed above to help you buy your dream house.