Just got a phone call from a couple thinking of filing Chapter 13 bankruptcy. However, their adjustable rate mortgage is about to adjust—most likely upward—within the next five to six months. They want to know how the Chapter 13 filing will affect their opportunity to refinance?
In short, it’s going to be ugly. It’s always best to avoid filing bankruptcy, especially if you need to refinance any time soon. (Check out What You Should Know Before Filing For Bankruptcy.)
If you didn’t know, with Chapter 13 bankruptcy you’re basically restructuring your debt. When you’re approved for it, you’ll most likely be in a program where you pay off your debt within the next three to five years. It’s a great program, but it should be looked at as a tool of last resort. With it you can forestall foreclosure, keep all of your property, freeze your debts and your creditors who are out for blood can’t garnish your wages—as long as you make your bankruptcy payments on time. But, if you have an adjustable rate mortgage and your interest rate is about to fly to the moon, Chapter 13 bankruptcy won’t help you a bit.
Back during the subprime heyday, many subprime lenders would allow you to refinance a day after being discharged from bankruptcy. Most conventional lenders would allow you to refinance, but only after being discharged from bankruptcy at least 24 months, with more conservative lenders making you wait 36 to 48 months. However, the FHA would allow you to refinance while you’re in bankruptcy. To be clear, you’d probably have to be in Chapter 13 for at least a year and be able to prove that you’ve made all your payments on time. Plus your bankruptcy trustee would have to allow you to refinance.
So, what do you do? Gut it out and avoid filing for Chapter 13 bankruptcy if you’re able to. And, if you feel you must file, do everything humanly possible to refinance beforehand and save yourself from plenty of agitation and aggravation. I know, it seems quite tempting to file for bankruptcy, lower your payments and get back on track, but take everything into consideration before doing so. In the best case scenario, if you file for Chapter 13 bankruptcy you’ll have to wait at least a year before you’re able to refinance with FHA. Maybe President Obama will save you with some more great economic stimuli aimed at bankruptcy processes, but don’t bet on it just yet. The water is still a little too murky in the financial sectors to take chances with your wealth and your home.
Kirk Charles, a.k.a. The Mortgage Confidant, is a mortgage consultant and author of The Real Deal: How to Get a Mortgage During & After the Subprime Crisis