William Heckner had refinanced his Carney home once before -- back in 1995 -- to help him get out from under a burden of debt. Toss the credit cards. Make a fresh start. So what if he had to take a 10.5 percent mortgage. You do what you have to do.
He had good intentions, but financial pressures began to rise again. There was his son's tuition at Calvert Hall College high school. His wife -- a nurse -- was going back to school as well and was planning on opening a practice. He didn't adjust his spending habits.
The bills began to pile up again. Out came the credit cards. Five of them. And it didn't take long for him to rack up $65,000 in outstanding balances. That's a lot to pay off when you're only making $12 an hour working at Home Depot.
Maybe refinance again, Heckner thought to himself. Rates had dropped to 7 percent. He could save a couple of hundred dollars off his mortgage and that would help him make a dent in his debt.
But Heckner soon learned that he had so much debt no lender would touch him. What to do?
"I was told from a mortgage broker to go ahead and file bankruptcy," Heckner said, recalling that the broker told him, "It's the best thing for you, you'll wait three months and after three months I will be able to get you a refinance the day after."
It turned out to be the worst advice he got.
Heckner filed for Chapter 7 reorganization in Novem ber. He kept his wife and his house out of the proceedings. In February, he was discharged by the court and he thought he was well on the road to refinancing his home once again.
"The next thing I know is that I am getting stalled, getting the runaround from the one guy," Heckner said. "I went to another person. The other person says, 'Well, you have to wait a year.' Great. I go to another person, another finance company, 'Well, you have to wait two years.' "
Heckner was drowning in a sea of misinformation.
Getting a second chance
Mortgages and bankruptcies have never been comfortable bedfellows. Does having a bankruptcy ruin an applicant's chances of obtaining a mortgage with favorable terms? Industry professionals say it depends on the lender, what financing program is being offered and the circumstances that caused the bankruptcy.
Take DiAngela and Ahmed Miller. With personal bankruptcies in both of their pasts, they didn't think they could ever buy a house.
But on Aug. 17, they moved into their first home, a single-family house in Randallstown.
More than a year ago, the Millers met with Brian Sachs of Integrity Home Funding in Owings Mills, whose company specializes in helping people one to two years out of bankruptcy get mortgages.
"There's an opportunity for folks who don't think there's any opportunity," Sachs said.
The first step to homeownership for the Millers was not trying to buy a home. "They weren't ready to buy," Sachs said. "I had to customize a plan for them to become 'mortgable.' "
Hidden cost of bankruptcy
Sachs organized a program to make them creditworthy that included maintaining a timely rental history, securing a credit card and making monthly on-time payments and attending a homeownership counseling program. After one year, they were ready. The Millers applied for and received a mortgage.
But people who have gone through a bankruptcy in effect must pay a penalty for their bad credit history. There's an element of risk in lending to those with less than perfect credit, and that risk factor translates into a high interest rate such as 9 percent to 11 percent compared with a market rate of 7.75 percent on a conventional 30-year, fixed-rate home mortgage.
Sub-prime lenders don't make these loans out of charity, but despite the high risk they are enormously profitable. The Millers paid three points -- one point equals 1 percent of the loan amount -- to get a reasonable interest rate in the 8 percent range.
"Bankruptcies result from two main causes: financial mismanagement or some catastrophic event," explained Frank Weaver, president of Atlantic Home Equity. "In the overwhelming cases we encounter, it's someone who's over their head in debt because of credit cards."
Then there's bankruptcy or severe credit problems caused by "extenuating circumstances." It's usually a one-time event that is beyond a person's control such as a death in a family, a prolonged illness, or a sudden job layoff.
One of Weaver's customers was a man who had an excellent credit record before his son developed leukemia in 1996. But the heavy medical expenses for his son's treatment put an enormous financial burden on him and, as a result, he couldn't pay his bills. His credit was destroyed.
"His situation was as bad as filing bankruptcy," Weaver said. By mid-1998 though, the father started to reacquire "successful credit management skills" -- the mortgage industry lingo for re-establishing good credit. This year, Weaver's applicant qualified for a home mortgage, but at an interest rate two percentage points higher than what would be charged to someone with perfect credit.
"The isolated nature of the circumstance, [his] prior good credit and his strides to re-establish good credit were the reasons we granted the loan," Weaver said.
In the Millers' case, DiAngela was in debt because of credit-card spending in college, and Ahmed's bankruptcy was precipitated by a family crisis in his first marriage.
When it comes to a standard guideline for making conventional loans to people who have declared bankruptcy or who have chronically bad credit, most of the industry abides by the one set by Fannie Mae.
Fannie Mae buys mortgages issued by banks, thrift institutions and other mortgage lenders, then packages the loans and sells them to investors as mortgage-backed securities. When Fannie Mae buys the mortgages from lenders, it provides the lenders with the cash needed to issue new mortgages.
Who gets loan, who doesn't?
If lenders want Fannie Mae to buy their loans, they must meet its underwriting criteria which states "the quality of an applicant's credit history" is one of the most important indicators of how a mortgagee will perform.
"We are interested in what mortgage risk that borrower represents when he comes in for a loan," said Chip Caffey, director of credit policy at Fannie Mae. Fannie Mae does not want to buy mortgages that will eventually go into default.
Regarding bankruptcies, Fannie Mae requires four years to pass from the time the bankruptcy was discharged for an applicant to re-establish credit. The time period used to be two years, but because its research into mortgage performance showed that those who had declared bankruptcy had a much higher chance of defaulting on the mortgage than someone with no bankruptcy, the organization changed its underwriting guidelines last year.
Another factor for the change was the increasing number of bankruptcies. Last year, according to the Administrative Office of U.S. Courts, personal bankruptcies nationwide rose 9 percent even though the number of business bankruptcies fell.
"We saw a trend in bankruptcy and took the appropriate steps," Caffey said.
However, Fannie Mae does show compassion for those who can prove they went into bankruptcy because of extenuating circumstances. In those cases, it will accept a two-year interval. Still, the most important criteria is whether the applicant has re-established a good credit record in the two- or four-year time period.
In Fannie Mae's eyes, a good credit history means all credit accounts are current at the time of the mortgage application. No installment debt can be more than 60 days past due nor can any housing debt payments -- such as rent -- be past due. They also require a minimum of four credit references.
Other major government lending agencies have their own guidelines, such as the Federal Housing Administration which also increased its time period to consider a mortgage after a bankruptcy from 12 months to 24 months.
But along with his or her credit history, the applicant's credit score also is evaluated.
Credit score card
Credit scores are used by lenders to determine the likelihood of an applicant defaulting on a loan. The scores range from 800 for a person with excellent credit to 500 for a person who has a great risk of defaulting. An acceptable credit score for Fannie Mae and its sister mortgage concern, Freddie Mac, for a creditworthy applicant is 620. A score of 660 or higher indicates the applicant has successfully re-established his or her credit.
Sub-prime lenders mainly deal with applicants whose credit score falls below the threshold, said Julie Hataway, product development manager for the Provident Mortgage Corp. Those above that threshold with a good credit history are considered prime customers with "A" credit.
The rest is called the sub-prime group or "B, C and D" applicants. This is the category of customer who has gone bankrupt or has had major credit problems.
The sub-prime applicant is evaluated on his credit history since the bankruptcy, current income, and also the amount of down payment he or she can make. Along with a higher interest rate that reduces the lender's risk comes a higher down-payment requirement.
While an "A" customer may be required to make a minimal down payment -- 5 or 10 percent -- a "D" may have to come up with a 35 percent equity stake in the house.
Stigma no more
Bankruptcy once had a social stigma attached to it, said Linus Campbell of the Consumer Credit Counseling Service, but not anymore. It is seen as a convenient way to get out from under overwhelming debt problems.
"For past generations, it was never a consideration, but today it is," Weaver said. Congress has recognized this and is in the process of enacting legislation revising the Bankruptcy Reform Act of 1994, making it harder to file for bankruptcy protection.
Campbell cautioned those emerging from bankruptcy about taking on a mortgage, and said if they do, they should deal with a reputable lender. There is still a segment of brokers who practice predatory lending, preying on the financially desperate, especially in low-income areas.
A reputable lender will not grant a loan to a customer who has not repaired his credit standing, especially one who has fallen back into financial irresponsibility since the bankruptcy.
'50% learn their lesson'
"Some have taken advantage of the legal system and don't change their spending habits," Weaver said. "About 50 percent learn their lesson."
Most lenders agree that some people are so irresponsible in their spending that they can never get a mortgage.
Most sub-prime lenders, such as Integrity, have programs that help customers re-establish their credit, bridging the gap between bankruptcy and the purchase of a home.
Emerging from a bankruptcy is a slow process that takes discipline and patience, but in the end homeownership can become a reality. After the purchase, the "B, C, & D" buyer can prove to a lender that they are no longer a poor risk and eventually refinance the higher-interest loan down to an "A" rate.
The goal of bankruptcy is to put a person back on his feet financially, but most lenders will agree that it's up to the individual whether she succeeds or fails.
"To the underwriter who's considering you for a mortgage, bankruptcy was an opportunity to start anew, but don't screw up again," Weaver said.
For William Heckner, after getting straight talk from Sachs of Integrity Home Funding, he learned that refinancing his home wasn't viable for now, and that it would take perhaps two years before he could be considered creditworthy again.
Said Heckner: "My advice to people who are going through this is to seek help. Seek someone, a reputable company. I had gotten bad advice to begin with and got misinformation -- misinformation that was vital in making my decision. If I would have known this stuff, I would have looked for other ways out."