Make Bank Off Bankruptcies

Brian Sacks, branch manager and national mortgage expert at Homebridge Financial Services, sees their potential.

“I view these as what we lend on are accidents waiting to happen,” Sacks said. “It’s far better to deal with someone whose accident has already happened because they can’t file bankruptcy again for another seven years.”

FHA Refinances

David Luna isn’t just a charismatic NMLS instructor; he’s also a veteran of the mortgage industry and knows how hard it can be in a down market. Back when he was a loan officer and business was slow, Luna said he would go down to the bankruptcy court and ask the clerks for a list. Nowadays, you can find this list online at PACER.

This list (which is public information) would include all state residents who have filed bankruptcy. Specifically, he would look for debtors who:

1. Are homeowners
2. Have been in their home for at least five years
3. Have equity in their homes
4. Have been in Chapter 13 bankruptcy for at least two years
5. Have been current on payments for the last 12 months

After finding these borrowers on PACER or by going to the bankruptcy court for a list, Luna would write a letter to the bankruptcy attorney and trustee of the court that is essentially a sales pitch. He would explain that he was a certified mortgage loan originator, state how many years he has worked in the industry, and how he would like to help their clients. It is necessary to get the trustee’s and sometimes the attorney’s permission before working with the client.

Listen to David Luna discuss his experience using bankruptcies as leads on this episode of Gated Communities.

After receiving this letter, the trustee of the court and attorney may want to set up a meeting with the inquiring loan officer. But Luna assures that this will only happen once or twice before they begin to automatically approve the letters. Once the trustee of the court gives the loan officer permission to pursue the client, the loan officer is set to proceed.

Now, let’s look at why Luna has these five qualification rules previously mentioned. First, finding a homeowner takes care of the inventory problem. They don’t have to go house hunting for an affordable property in a highly competitive market.

Why should someone be in their home for at least five years? Because today’s interest rate — that newer homebuyers complain is too high — is the same level interest rate homeowners were paying five years ago. Just make sure the income they’re making is comparable as well.

Why should someone be in Chapter 13 bankruptcy for at least two years? Luna said, “If they’ve been in Chapter 13 for at least two years, I know I can go backwards and possibly find 12 months of fulfilled payments.”

Of course, loan officers can also consider contacting people who have only eight months of good payments.They can give them a call and say “Let me know when you make that 12th payment to the court and we can get you set up for a refinance,” so the borrower and LO can prepare in advance.

Why does the debtor need to have equity in their home? To help pay off their debt.

“I think we can all agree that over the last few years, appreciation has really risen and now they have equity,” Luna said. “So we just pay off the bankruptcy court, which gets another file off of that trustee’s desk. And trustees are really happy about doing that.”

Matthew Zimmelman, NYC principal law attorney and licensed real estate broker, said he has seen this work for a number of his clients. Zimmelman has helped thousands by way of bankruptcy filings or developing strategies and careful planning to help others avoid bankruptcy. Recently, one of his clients was able to exit bankruptcy with a cash-out refinance after only two and a half years.

“Refinances certainly can be helpful,” Zimmelman said. “In this case, they used a cash-out refinance where they also pulled some additional equity and used that to pay off the remainder of the other debt within the bankruptcy. So now they’ve exited bankruptcy early and they’re essentially debt free, with the exception of just this new mortgage.”

Using this strategy, Luna said a loan officer could potentially close an extra five, 10, 20 loans per month.

FHA Purchases

One of Sacks’s most memorable clients was a female NICU nurse who went through bankruptcy and foreclosure. She had been working in the NICU for 30-plus years, and her husband was “a piece of work,” Sacks said. He became physically and verbally abusive, and a drug addict. With very little money, the woman fled from her husband with her daughters and her daughters’ kids.

“I said to her, ‘But you’re a NICU nurse. You’ve been a NICU nurse at University of Maryland for 35 years. I’m sure you have some sort of retirement account, right?’ She said, ‘Yes.’ Well, we used some of her retirement funds to get her into a home very shortly after the bankruptcy. It was a high rate, to be fair. But a year later we refinanced her and her payment was significantly lower than it would’ve been had she rented,” Sacks said.Many folks in bankruptcy don’t think they’re eligible for a home purchase until after seven to 10 years, but this woman Sacks helped only one year after being discharged from Chapter 13 bankruptcy. But in many circumstances, even for purchases, debtors don’t have to be discharged to get an FHA loan.

“You have to be paying for one year and get the approval of the court from the trustee so that it won’t interfere with your bankruptcy plan,” Sacks said.

Doing purchase loans for folks in bankruptcy can be a bit more complicated, but it’s absolutely worth adding more loans to the pipeline and the joy of helping those going through hard times. That being said, there are some additional criteria Sacks recommends for those wanting to do purchase loans for Chapter 13 bankruptcies.

He typically looks for Chapter 13 bankruptcy folks making at least $75,000 a year in income, are currently renting, and have filed bankruptcy more than one year ago or as far back as five years ago. These borrowers are also expected to have poor credit, which is why FHA with a 580 FICO score qualification is recommended.

Sacks has also taken on clients with a 500 FICO score. In these cases it is necessary for the loan officer to inquire why the credit is so low, and determine whether this client should attempt to repair it by using a credit card.

“When you have folks who’ve had a bankruptcy, it could be due to errors in their report,” Sacks said. “So sometimes it’s simple. You can fix the credit report just by sending it back and having it reported accurately.”

Sacks also suggests advising the client to take out a few credit cards. It’s okay if it’s a secured one where the consumer pays a cash deposit upfront to guarantee their credit line.

“Buy gas for 50 bucks, pay it off; buy groceries for 50 bucks, pay it off. And then, I might follow up with them again in six months. See how they’re doing, see if they’re ready,” Sacks said.

Sacks was recently able to close a deal with a client that took three and a half years to improve his credit.

“He couldn’t get out of his own way,” Sacks said. “He was a single dad with three little boys. But you know, he sat at the settlement table and cried. He said no one else would’ve taken the time. But, what time is a three-minute phone call? How are you doing? How are you doing with what we talked about? Not good. Okay. We’ll call you again.”

Referral Sources

Consider this opening: Hi, I’m Katie Jensen. I’m a mortgage loan officer who offers great rates. I have excellent service, and offer a great product mix. I’d love to be able to meet your agents.

That pitch is not likely to go anywhere. Plenty of realtor offices have their own in-house loan officer who can handle a variety of products. Instead, look at Sacks’s pitch:

“Hey, I know that you have your own in-house loan officer, and I know they do a tremendous job, and I know your agents have great relationships with other loan officers as well. But I’m able to help you and fill in a crack that your loan officers may not be able to handle. I’m able to work with some of the buyers you’re turning away. Maybe because they had a bankruptcy, maybe because they have a credit challenge. Would your agents be interested in discussing this further?”

Realtors will be much more receptive to a pitch like that, because Sacks is offering a unique service — not many loan officers willingly and purposefully seek out folks in bankruptcy.

Teaching classes about this to realtors is also another way to build referral sources. Teach them how people in bankruptcy can get a mortgage before they’re discharged, and what qualifications are expected. That is an efficient way to gain referrals because then the loan officers come across as experts and they’re speaking to 10 or 20 realtors at once.

It’s also important to develop a partner relationship with one or a few bankruptcy attorneys. Zimmelman has a few tips and warnings for loan officers who are attempting to build a relationship with a bankruptcy attorney. He advises that a loan officer knows what the process is like and not come off too eager to get the loan closed quickly.

“It’s rare that I can rush and get an approval for a loan if you tell me, ‘Hey, we need to close in three days,’” Zimmelman said. “I need the terms and I need the time. You must have that understanding and not just act like the stereotypical, aggressive mortgage broker or mortgage lender who just wants to plow through 17 deals, like let’s make all this happen immediately. It just doesn’t work that way.”

Zimmelman usually tells his clients it’ll take one to two months to get the approval of the court. An application can’t be filed without the terms of the loan being approved by the trustee of the court and a judge. It can take weeks or months before a judge even sees it. The attorney must appear before the judge for the motion to be granted and signed. Many delays can hold up this process, but only after its completed can the client proceed with the loan.

Coming off too ambitious can leave a bad taste in some people’s mouths. It comes off as scam-like or greedy when a loan officer is acting too aggressively. For example, Zimmelman says he doesn’t like it when loan officers pull a list of all his bankruptcy filings and active cases, then show up at his office saying they can help x, y, and z clients get a mortgage.

“I look at it as almost stalker-like,” Zimmelman said. “If it’s someone I haven’t met yet or we just scheduled their first meeting, and now you’ve come to me saying, ‘Hey, I know you filed cases for … ’ and just run through a whole slew of names. Yes, it’s all public records, but slow down.”

In that first meeting, loan officers should focus on demonstrating their understanding of the bankruptcy process, then explain what they’re capable of doing to help the attorney’s clients. This will help establish trust. From there, the attorney will decide if this loan officer is useful or not. If they are, the attorney will follow up and say, “I think you can assist. Let me go back through my clients, see what I can find, and then we’ll have a follow up meeting.”

Zimmelman also doesn’t like it when loan officers go straight to his clients, telling them they can absolutely qualify for a mortgage. Oftentimes, his clients call him saying they’ve spoken to a loan officer who can get them a mortgage or a refinance. He said this leads the client to have unrealistic expectations based on the conversation they had with this loan officer, and that may not fall in line with the way things actually work. He would rather partner with a few loan officers that understand the process.

“Rather than approach the client, get them all excited, and now they think that we can just make this happen quickly.  I could build that partnership with a professional or a handful of professionals, and potentially reach out to my clients and say, ‘This might be an option. Would you be interested in speaking to somebody?’ And if they’re interested, then I could pass along a couple of phone numbers and everyone knows how this process works, and now we’re all working together rather than someone being sold an idea,” Zimmelman said.

The Wave Is Coming

Experts like Sacks and Zimmelman foresee a spike in bankruptcies later in the year as pandemic aid comes to an end and poor economic conditions — caused by rising interest rates and high inflation — putting more stress on household budgets.

“You’re seeing the economy become much more challenging and difficult, and that’s when bankruptcies spike,” Sacks said.

Bankruptcy filings spiked in January 2023, up 19% from the previous year, according to data from legal research firm Epiq. The number of people who filed bankruptcy across Chapter 7, 11, and 13 shot up 20% in January from last year.

As the year goes on it seems the bankruptcy filings are piling on. In March, total filings were 33% higher than in February. Individual chapter 13 filings during the first quarter 2023 were 42,364, a 28% increase over the same period last year.

“My goodness,” Luna said. “Having a solution for these people is really going to change many families and individuals’ lives.”

Borrowers don’t need Chapter 13 discharge

According to HUD guidelines on FHA loans mandated by HUD 4000.1 FHA handbook, borrowers can qualify for an FHA 203(b) loan in Chapter 13 bankruptcy during the repayment plan and do not need to wait until they’re discharged — as long as the borrowers have made their payments for at least 12 months.

“A lot of people believe that borrowers have to be discharged from a bankruptcy, which is not true,” David Luna said. “Borrowers can take out a loan while they are currently in a Chapter 13 bankruptcy. This does not work for Chapter 7 or Chapter 11, just Chapter 13.”

Please note that some states like Texas have Homestead Laws, preventing banks from seizing property, so this strategy might not apply to every state but it will apply to most. Luna suggests loan officers speak with their local account executive to see if they can get Chapter 13 debtors to apply for FHA.