The USDA Loan and Bankruptcy Seasoning
Understanding how the USDA Loan looks at Bankruptcy
A bankruptcy does have a substantial impact on your credit and your ability to get a new USDA Loan to buy a house.
A bankruptcy is defined as a federally authorized procedure by which a debtor is relieved of total liability for its debts by making court-approved arrangements for their partial repayment. Now there are two types of bankruptcies that apply to individuals and the USDA Loan treats them both differently.
First is the Chapter 7 which is the liquidation bankruptcy. In the Chapter 7, a trustee of the court will collect non-exempt assets and liquidate them to pay a portion of the debts that are owed. Once completed, or discharged, the individual is free from debt.
The other is the Chapter 13 bankruptcy. In the Chapter 13 the trustee of the court will create a Repayment Plan where the individual will make payments to the court over a series of years until the debts are paid in full. Then a discharge is issued.
There is a lot more to a bankruptcy, and for more information you could use our friend google or head on over to the free dictionary dot com.
There are two more things you need to know… 1 – how the USDA Loan will handle bankruptcies and 2 – How lenders who fund the USDA Loan will underwrite bankruptcies. Just remember, that the USDA does not actually fund the loan. The funding comes from various lenders.
So let’s first see how the USDA Program handles bankruptcies.
The USDA guidelines are known as the 1980. If we look at 1980.345 section d.1.viii it reads like this.. “Any debts written off within the last 36 months are considered unacceptable credit.” And a bankruptcy would fall under this category..
As they said in the old Ginsu knife commercials… “but wait, there’s more..”
Because in the prior section it reads “unless the cause of the problem was beyond the applicant’s control”…
So, if the cause of the bankruptcy was due to a circumstance beyond the control of the borrower, then it can be possible to get approval for a USDA loan.
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If we continue reading, section d.3 tells us exactly how to prove that situation.
We need to prove that the cause of the problem was: temporary in nature, beyond the applicant’s control, and have been removed. Examples given in this section include: loss of job, reduction of government benefits, loss of income, increased expenses due to illness, or death.
So if you had a bankruptcy within the last 36 months and you can prove that it was caused by a circumstance beyond your control, then you have a fighting chance to get a USDA loan approval.
Now, let’s talk about the other side of this… how the lender’s underwriter will evaluate a prior bankruptcy.
All lenders have overlays, which mean that they have their own internal rules that trump the USDA guidelines. So it is more important to know your lenders overlays than it is to know the USDA rules.
Most lenders will just flat out require that a bankruptcy be discharged 36 months, period. Some will consider a chapter 13 after being discharged 1 year.
But there are lenders who will have a much leaner bankruptcy overlay and follow the USDA guidelines very closely. This type of lender will typically want to see any type of bankruptcy have at least 3-4 established credit trade lines reporting on the credit report in order to show that you are rebuilding credit. In most cases this would take at least 12 months to accomplish.
As you can imagine, this type of lender is much more difficult to find. We do have a small handful of lenders that fit into this category that we do work with.
I hope you found this Arizona Home Loan tip useful and would love to hear your comments.
To find out if you qualify for a USDA Loan call (520) 225-0380 or click on the Get Started on USDA tab above and ask for a quote. If you want to go ahead and get your application in, you can fill out my Home Loan Application Online here.