Bad Credit Series: Home Equity Loan After Bankruptcy

The day you went to court and filed for bankruptcy was most likely one of the most stressful days of your life. But when the creditors won’t stop calling, you can’t seem to make a dent in the massive credit card debt you’ve racked up, and your mortgage company is threatening to take the house, there aren’t that many options. Filing for bankruptcy can grant the relief you need so you can get a financial fresh start.

But that new beginning comes at a price. For the next seven to ten years, getting financing for anything can be tricky. If the car dies or something goes wrong with the house, coming up with the lump sum to deal with the issue can be a challenge. If you emerged from your bankruptcy with your mortgage intact, a home equity loan might seem like a plausible option. Maybe. The problem is, lenders might be nervous about lending money to someone who had issues handling their finances in the past. This is not to say that getting a home equity loan is impossible, but the process might not be a walk in the park.

Why Get a Home Equity Loan After Bankruptcy

Roofs leak, pipes burst, and kitchens need to be updated regardless of your financial situation. Keeping your home in its best condition is wise both for your finances and from a safety standpoint. But there are other reasons you might want to take out a home equity loan, such as a down payment for a car, college tuition for your kids, a wedding, or some other major expense. A home equity loan can help you meet your financial needs, usually in a less expensive fashion than a traditional loan or credit card. Getting a home equity loan after filing for bankruptcy might be a challenge, but it’s not totally impossible.

Types of Equity Loans

There are two main types of home equity loans. A home equity loan is a lump-sum loan taken out with the home used as collateral. Borrowers with excellent credit can take out home equity loans equal to the value of the home. For those with problematic credit, such as a bankruptcy, most lenders will loan only up to 80% of the value of the home.

The second type of home equity loan is a home equity line of credit (HELOC). HELOCs are like a credit card. You have a credit limit, and you can take out and use a little at a time as you need it. For many borrowers, this feels like a safer alternative because they can better control the amount of additional debt they are taking on.

It Could Take a While to Qualify

Qualifying for either a home equity loan or a HELOC after filing for bankruptcy is not a quick process. Generally speaking, 18 months after the bankruptcy has been discharged is the earliest a lender will consider offering a line of credit. Many lenders require the time between discharge and approval to be five years or more.

Your best bet is to go to the lender that has your current mortgage. If that’s not an option, you can try another lender with whom you already have a positive working relationship, such as your local bank or credit union, and try to get a loan through them. But even that might not be enough to get your loan approved. So if you were thinking of getting a home equity loan or a HELOC as a quick fix for another issue, you might want to switch to plan B.

The Type of Bankruptcy Matters

Both the type of bankruptcy you filed and the reasons for the filing matter. More about the reason in a moment, but first, there are two types of bankruptcies consumers tend to file: Chapter 7 and Chapter 13. In a Chapter 7 filing, you’re seeking relief from your debts through the court system. You may ask to retain certain assets such as your home and a vehicle, but all other debts are erased and you have a fresh start. Once a Chapter 7 bankruptcy is granted by the courts, all collection attempts must stop.

A Chapter 13 bankruptcy is different. You might need help reorganizing or negotiating your debt, but you’re willing to pay it through a repayment plan. If a court agrees to the proposed plan, then you’ll repay the debt over the next three to five years. Once the debt has been repaid, the bankruptcy is considered satisfied.

Lenders might look at a person who filed and completed a Chapter 13 bankruptcy more favorably and may be willing to extend a home equity loan or a HELOC more quickly than they might to someone who filed a Chapter 7.

Another factor that lenders will take into consideration is why you filed for bankruptcy to begin with. Filing for debt relief because of large medical bills or a major life change like a divorce is usually viewed differently than filing because you simply got in over your head with credit cards and car loans. Talking to an actual lender and explaining your situation might help you make a case for a home equity loan or a HELOC.

Consider Other Options

A home equity loan or a HELOC might seem like a great idea, but perhaps there are other alternatives you could explore that don’t require you to take on another large amount of debt. If the purchase isn’t something you need immediately, try paying cash for it after saving for it. What is important to remember is that a home equity loan or a HELOC puts your home on the line. Default on that loan, and you very well could lose your house. At the very least, you need to make sure that the old habits or the situation that resulted in your filing for bankruptcy have been taken care of. Otherwise, you might end up back where you started, and no one wants that to happen.