Can You Get a Home Equity Loan After Bankruptcy?

If you were among the nearly 700,000 people who filed for bankruptcy between June 2019 and June 2020, you may be wondering if you can borrow from your home equity after bankruptcy. The short answer? Yes, borrowing from your home equity may be an option, depending on your lender and financial circumstances. Typically, tapping your home equity is a better option than a personal loan or a credit card, as home equity loans usually have lower interest rates.

Understanding bankruptcy and home equity loans

Bankruptcy, a legal procedure for people who cannot pay their debts, allows consumers to eliminate their debt or restructure it to make repayment possible. Filing for bankruptcy offers an opportunity to regroup and get a fresh start on your finances.

Bankruptcy will impact your credit history and your credit score, which in turn impacts how soon you can get a line of credit after bankruptcy. A Chapter 7 bankruptcy will stay on your credit report for up to 10 years, while a Chapter 13 bankruptcy will stay on your credit report for up to seven years. The impact on your credit score depends on several factors, including your score before bankruptcy. For example, if you had a high credit score, you should expect to see a bigger drop than someone with a lower score who had existing negative marks on their credit report.

If you were able to keep your home after bankruptcy and have equity in the property, you may be able to access that equity to improve your finances. You typically have three options to tap into your home equity after bankruptcy: cash-out refinance, home equity loan and home equity line of credit.

• A cash-out refinance replaces your current mortgage loan with a new, larger one. You can keep the difference between the previous loan amount and the new loan in cash or use it to pay off other debt.
• A home equity loan is a second loan on your property. You’ll receive the loan proceeds in a lump sum and then pay it back, typically with a fixed rate and a term of five to 30 years.
• A home equity line of credit (HELOC) is a revolving line of credit that you access like a credit card. Your payments are based on the amount you use, not the full line of credit. Most HELOCs have a variable interest rate.

How to tap your home equity after bankruptcy

Can you get a home loan after bankruptcy? Possibly, but it will take time. Remember, the negative impact on your credit report and your credit score will linger for years after a bankruptcy. As soon as you can, work on improving your credit score. You might try and qualify for a secured loan or a credit builder loan. Pay all your bills on time and pay down any lingering debts to increase your credit score.

The length of time it’ll take you to re-establish credit after bankruptcy and become eligible to apply for loans varies depending on the type of loan you want to get, how much you want to take out and who your lender is.

More than likely, you’ll need to wait anywhere from two to seven years after your bankruptcy to qualify for a cash-out refinance, home equity loan or HELOC. Each lender will treat a loan applicant with prior bankruptcies on a case-by-case basis, so you should consider speaking to several banks and credit unions to understand what options are available to you. You should shop around with multiple lenders to see if you can get a home equity loan after a Chapter 7 or Chapter 13 discharge.

It’s important to explain to each lender why you declared bankruptcy. While lender decisions are based on numbers like your credit score, home equity, income and assets, they may be more understanding of financial hardships caused by illness, death, divorce or unemployment rather than credit card debt.

Every homeowner who applies for a HELOC or home equity loan will need to meet lender requirements.

• You can typically borrow up to 85% of your home value, including your primary mortgage and a HELOC or home equity loan.
• You’ll likely need a minimum credit score of 620, but many lenders require a higher score.
• Your debt-to-income ratio usually needs to be 43% or lower, which means your minimum payments on recurring debt must be 43% or less of your gross monthly income.

For cash-out refinancing, your minimum credit score and debt-to-income ratio requirements are similar to those for HELOCs and home equity loans. You may be able to borrow up to 80% of your home value with a typical cash-out refinance, and closing costs can be wrapped into the loan amount.

When applying for a loan to tap into your home equity, you may need an appraisal to determine the current market value of your home.

Pros and cons of tapping your home equity after bankruptcy

Even if you can qualify for an equity loan after bankruptcy, that doesn’t mean it’s your best financial option. Depending on the reason for your bankruptcy, you may need to resolve cash flow issues or a tendency to accumulate too much debt before borrowing your home equity after bankruptcy. Consider these pros and con before you borrow:

Pros

  You may be able to borrow at a low interest rate. Most home equity loans and cash-out refinances will offer a significantly lower interest rate than credit cards and personal loans.

  You may have access to more money. The amount you can borrow depends on how much equity you have in your home, but it could be more than a credit card or personal loan.

  You can use the cash from a home equity loan or cash-out refinance for several purposes. You can make home improvements, consolidate debt or pay for tuition, or open a HELOC for an emergency fund.

  You may be able to deduct the interest on the debt on your income taxes. Interest paid on home equity funds used for home improvements may be tax-deductible.

Cons

  You risk losing your home if you can’t make the payments. Unlike credit card debt or a personal loan, your home is collateral for home equity loans and refinances. If you cannot make the payments, you risk losing your home to foreclosure or being forced to sell it.

  You lose part of an important asset. When you borrow from your home equity, it can take years to repay the loan and regain that equity. If you sell your home while you still have a balance, you’ll have to use part of your profit to pay back the loan.

  You’re in danger of being underwater on your loan. If home values decline, you could owe more on your property than it is worth, which is known as being “underwater.” If you had to sell your home when you’re underwater, you would need a source of cash to pay off your equity loan.

  You’ll pay closing costs that will increase your loan balance or require cash. Closing costs typically range from 2% to 5% of the loan amount, which you can pay upfront or wrap into your loan. You’ll need to stay in your home longer to recoup those costs and rebuild your equity.