The Unusual VA (and FHA) Loan Qualification Rule After A Business Bankruptcy

Summary: If you've experienced a business bankruptcy and are looking to buy a home, there is a lesser-known VA and FHA loan guideline that might significantly reduce your waiting period before qualifying for a home loan. This article explores this unusual rule, the specific conditions you must meet, and how it can benefit veterans and non-veterans alike. Whether you’re self-employed or have recently transitioned into a permanent position, understanding this exception could help you achieve homeownership sooner than you thought possible.

Table of Contents

• Understanding the VA and FHA Loan Waiting Periods After Bankruptcy
• Bankruptcy Types and Their Impact on VA Loan Waiting Periods
• Four Critical Conditions to Qualify for the Reduced Waiting Period
• Important Considerations When Using This Rule
• Who Can Benefit From This Rule?
• Frequently Asked Questions (FAQ)
• Final Thoughts

Understanding the VA and FHA Loan Waiting Periods After Bankruptcy

Buying a home after a bankruptcy can feel daunting, especially when it comes to understanding the waiting periods imposed by lenders and loan programs. Typically, these waiting periods are designed to ensure that borrowers have re-established financial stability after a bankruptcy before they take on a new mortgage.

For VA loans, the waiting period usually starts from the date of bankruptcy discharge or filing, depending on the type of bankruptcy you filed. However, there is a special rule that can reduce this waiting period if your bankruptcy was caused by a business failure. This same rule also applies to FHA loans, making it relevant for a broader range of borrowers, not just veterans.

What Is the Waiting Period?

The waiting period is the time between the bankruptcy event (filing or discharge) and the closing date of your new home loan. It’s important to note that the waiting period is measured until loan closing, not the application date. This means you can apply and go under contract before the waiting period ends, but your closing date must occur after the waiting period expires.

Bankruptcy Types and Their Impact on VA Loan Waiting Periods

There are different bankruptcy chapters, and the waiting periods vary accordingly:

• Chapter 13 Bankruptcy: This type is relatively straightforward. The waiting period starts on the filing date, and you must have made 12 on-time payments (about one year). You do not need to have completed or exited the bankruptcy to qualify after this period. Whether you are self-employed or not does not affect this timeline.
• Chapter 7 Bankruptcy: The waiting period begins from the discharge date of the bankruptcy. The standard waiting period here is two years before you can close on a new home loan.

These waiting periods are designed to ensure that borrowers have had sufficient time to rebuild their credit and financial stability after bankruptcy.

The Unusual Rule for Self-Employed Borrowers

This is where the rule gets interesting for those who filed bankruptcy due to business failure. If your bankruptcy was caused by your self-employment or business failure, the VA guideline allows the standard two-year waiting period to be reduced to just one year.

This exception is outlined in Chapter 4 of the VA Handbook and applies under specific conditions. It also applies to FHA loans, making it beneficial for a wider audience.

Four Critical Conditions to Qualify for the Reduced Waiting Period

To benefit from this reduced waiting period, you must meet four strict criteria. These ensure that the bankruptcy was truly an extenuating circumstance related to business failure and that you are now on a stable financial path.

1. Permanent Employment After Business Failure: You must have obtained a permanent position after your business failed. This can also include being on disability or receiving Social Security benefits. The key is that you are no longer relying on self-employment that caused the bankruptcy. Restarting the same or a similar business is generally not allowed.
2. No Derogatory Credit Prior to Self-Employment: There must be no derogatory credit information on your credit report before you started your self-employment. Lenders will verify this by checking credit records, tax returns, and LLC filings to pinpoint when self-employment began. If any negative credit history exists before you became self-employed, the reduced waiting period does not apply, and the standard two-year wait returns.
3. No Derogatory Credit After Bankruptcy: Similarly, there must be no derogatory credit information after the bankruptcy discharge. This shows you have been responsible and are rebuilding your financial life with stable income.
4. Bankruptcy Not Due to Borrower Misconduct: The business failure and subsequent bankruptcy must not have resulted from borrower misconduct or illegal activities. This is to ensure that the hardship was genuine and not due to irresponsible or fraudulent behavior.

Meeting these conditions essentially proves that your life was financially stable before starting the business, the business failure was an unfortunate event, and now you are on a positive path with stable employment or income.

Why Does This Rule Exist?

The VA and FHA understand that business failures can happen to even the most responsible borrowers. This rule acknowledges that a bankruptcy caused by business failure is an extenuating circumstance deserving of leniency. It helps borrowers who are genuinely rebuilding their lives get back into homeownership faster.

It also discourages serial entrepreneurship where borrowers repeatedly open and close businesses, which can be risky for lenders.

Important Considerations When Using This Rule

While this rule is a great benefit, there are some important factors to keep in mind:

• Lender Overlays: Not all lenders will honor this reduced waiting period, even though it is allowed by VA and FHA guidelines. Some lenders have their own stricter rules, known as overlays, and may require the full two-year waiting period.
• Expert Guidance Is Essential: Navigating loans after bankruptcy, especially with this exception, is complex. Working with an experienced mortgage broker or loan officer familiar with VA and FHA guidelines is critical. They can help ensure all conditions are met and support you through the process.
• Documentation Is Key: You will need to provide thorough documentation to prove the timing of your self-employment, lack of derogatory credit before and after bankruptcy, and your current stable employment situation.

Who Can Benefit From This Rule?

This guideline is especially valuable for:

• Veterans using VA home loans who filed bankruptcy due to business failure
• Non-veterans applying for FHA loans in similar circumstances
• Self-employed borrowers who have transitioned to permanent employment or stable income sources
• Borrowers who want to reduce the typical waiting period and buy a home sooner

If you or someone you know fits this profile, understanding this rule could be a game-changer in your home buying journey.

Frequently Asked Questions (FAQ)

Q: Can I apply for a VA or FHA loan before the waiting period ends?

A: Yes, you can apply and even go under contract before the waiting period ends. However, the closing date must be after the waiting period has expired.

Q: Does this reduced waiting period apply to all types of bankruptcy?

A: No. For Chapter 13 bankruptcy, the waiting period is based on the filing date and making 12 on-time payments, regardless of self-employment. The reduced waiting period primarily applies to Chapter 7 bankruptcy caused by business failure.

Q: What if I restarted my business after bankruptcy?

A: Restarting the same or a similar business usually disqualifies you from the reduced waiting period. The VA and FHA want to see stable employment unrelated to the failed business.

Q: How do lenders verify the start date of my self-employment?

A: Lenders will review credit reports, tax returns, and LLC or business filings to determine when your self-employment began to ensure no derogatory credit existed prior.

Q: Can I work with any lender to use this rule?

A: Not necessarily. Some lenders have overlays that require longer waiting periods. Working with an experienced mortgage broker or lender knowledgeable about VA and FHA guidelines is critical.

Final Thoughts

Understanding the unusual VA and FHA loan qualification rule after a business bankruptcy can open doors for many borrowers who thought they had to wait longer to buy a home. If your bankruptcy was caused by business failure, and you meet the four key conditions, you might qualify for a reduced one-year waiting period instead of the usual two years.

This rule reflects a compassionate and practical approach to lending, recognizing that life’s setbacks don’t have to permanently derail your homeownership goals. If you’re considering buying a home after a business bankruptcy, make sure to seek expert advice and explore this option thoroughly.

If you have questions or need guidance navigating VA or FHA loans after bankruptcy, reach out to a seasoned mortgage professional who can help you understand your options and get you on the path to homeownership.