The Federal Housing Administration insures mortgages for borrowers with low and moderate incomes as well as borrowers with credit challenges. FHA loans differ from the strict underwriting guidelines of conventional loans, that is, non-government guaranteed loans. Borrowers with prior bankruptcy may still qualify for an FHA loan if they have followed through with the court's terms and conditions. They may even qualify after a Chapter 13 dismissal under certain circumstances.
A Chapter 13 bankruptcy involves making payment arrangements and paying off debts without forfeiting property. Unlike a liquidation bankruptcy, it requires the debtor to maintain a payment schedule set by the court trustee before discharge.
In contrast to a bankruptcy discharge, after which collectors may no longer recover payments, a dismissal occurs when something goes awry and the case cannot continue toward a discharge. Bankruptcy fraud, missed payments and missed deadlines may cause a Chapter 13 bankruptcy to be dismissed. In some cases, the debtor may choose to opt for dismissal rather than continue with the case.
The FHA can insure a loan for a borrower after a Chapter 13 discharge if at least two years have elapsed, the borrower has re-established good credit and made all payments on time since the discharge date. The same two-year seasoning rule applies to a Chapter 13 dismissal, as of the date it was dismissed. Again, the FHA underwriter must document that the borrower has used credit responsibly since the case's dismissal.
The FHA may consider a borrower for insurance prior to discharge or dismissal of the Chapter 13 bankruptcy if she has made all payments on time and satisfactorily for at least one year of the pay-out period; and the bankruptcy court trustee gives written permission for the debtor to enter into the purchase or refinance transaction.
A majority of FHA applications are submitted for approval via the agency's automated underwriting program, Technology Available To Approved Lenders. The system may generate an "Approve/Eligible" rating after a Chapter 13 bankruptcy, but if the bankruptcy has not been discharged for at least two years, the lender must downgrade the loan to "Refer" status for further evaluation with an FHA Direct Endorsement underwriter.
The DE underwriter manually underwrites the loan, generally with more scrutiny. The borrower must submit a letter of explanation regarding the cause for filing the Chapter 13 and the reason for dismissal. Final approval or rejection is at the underwriter's discretion.