USDA Loans After Financial Setbacks: Bankruptcy, Foreclosure and Short Sale

Experiencing bankruptcy, foreclosure or a short sale can be a challenging and emotionally-draining process. Aside from the financial ramifications, these events can leave individuals uncertain about their future homeownership prospects.

Fortunately, the United States Department of Agriculture (USDA) offers hope in the form of USDA home loans, designed to assist low-to-moderate income individuals in rural areas in achieving their dream of owning a home.

While bankruptcy, foreclosure and short sale may lead to added obstacles in your homebuying journey, these financial hardships do not prevent you from qualifying for a USDA loan in the future.

Getting a USDA Loan After Bankruptcy

Bankruptcy is a legal process that individuals or businesses go through when they are unable to repay their debts. It provides a fresh start by liquidating assets or establishing a repayment plan to settle obligations. There are various forms of bankruptcy, but we will look specifically at Chapter 7 and Chapter 13 bankruptcy when discussing how to qualify for a USDA loan.

Some applicants may be able to obtain a USDA loan more quickly than others who have filed for bankruptcy if they have experienced an extraordinary circumstance that led to their financial hardship. If you think this may apply to you, speak with your lender to learn more about qualifying for a USDA credit exception.

USDA Loans After Chapter 7 Bankruptcy

Chapter 7 bankruptcy is the most common form of bankruptcy in the United States. Often referred to as "liquidation bankruptcy," Chapter 7 bankruptcy involves liquidating an individual’s non-exempt assets to repay creditors. This is typically a quicker process when compared to Chapter 13 bankruptcy.

USDA loan applicants who have filed for Chapter 7 bankruptcy should consult their lender about qualifying for a credit exception if they are able to prove that their bankruptcy resulted from an extraordinary circumstance beyond their control, such as a severe illness or job loss, and that the issue has now been resolved.

USDA Loans After Chapter 13 Bankruptcy

Chapter 13 bankruptcy involves an organized repayment plan to creditors, typically completed within three to five years. In this scenario, individuals with regular income are able to reorganize their debts rather than liquidating their assets, unlike those filing for Chapter 7 bankruptcy.

To be considered for a credit exception after Chapter 13 bankruptcy, applicants typically must have an established repayment plan in progress, have made all required payments on time and receive written permission from their bankruptcy trustee to obtain new debt in the form of a mortgage transaction.

Getting a USDA Loan After Foreclosure or Short Sale

Foreclosure is the legal process by which a lender seizes a property when the borrower is unable to make mortgage payments in an attempt to recover the balance of the loan. It's relevant to note that the loss of a timeshare property is not considered a foreclosure according to USDA regulations, though this will likely still negatively impact your credit.

A short sale, on the other hand, is when the lender agrees to sell the asset for less than the balance of the loan. This option occurs most frequently among homeowners who are unable to keep up with mortgage payments but want to avoid foreclosure.

USDA loan applicants in these situations may qualify for a credit exception if the foreclosure or short sale was related to a filed legal separation or divorce, where the property was given to the other party. To be eligible, the applicant must provide documentation that the loan had been paid prior to the legal separation.

Tips to Help Qualify for a USDA Loan After Bankruptcy, Foreclosure or Short Sale

Resolve CAIVRS Files

CAIVRS stands for Credit Alert Verification Reporting System and serves as a database of individuals who have defaulted on federal obligations. Lenders will verify your status using CAIVRS when you apply for a USDA loan. To qualify for a loan, you must receive an "approved" CAIVRS result, meaning you have no outstanding credit issues including defaults, foreclosures or judgments.

Improve Your Credit for a USDA Loan

Rebuilding your credit after experiencing bankruptcy, foreclosure or short sale is essential to improve USDA loan eligibility. While these events may have left a negative impact on your credit score, taking proactive steps to enhance your creditworthiness will increase your chances of qualifying for a USDA loan.

Here are some effective strategies to improve your credit:

• Make timely payments: Pay all your bills on time, including credit cards, utility bills and any other outstanding debts.
• Establish responsible fiscal habits: Create a budget and stick to it. Limit unnecessary expenses and prioritize essential payments to ensure you have sufficient funds to cover your obligations.
• Monitor credit utilization: Keep a close eye on your credit utilization ratio, which compares your credit card balances to your credit limits. Aim to keep this ratio below 30% to show lenders that you are using credit responsibly.
• Reduce outstanding debt: Work towards reducing your existing debts, especially those with high interest.
• Seek professional guidance: If you are unsure about how to improve your credit or need personalized advice, reach out to a specialist at Neighbors Bank for a free credit consult.

The Bottom Line

While financial setbacks like bankruptcy, foreclosure or short sales may create obstacles on the path to homeownership, there are still potential ways to qualify for a USDA loan. With perseverance, responsible financial habits and the support of the USDA, borrowers may work past their previous hardships to begin their journey towards owning a home in a rural community and securing a brighter financial future.