Bankruptcy Discharge & VA Home Loans

Misreading a Bankruptcy Discharge Date VA Loan

Misreading a Bankruptcy Discharge Date VA Loan

I received one of those “I NEED HELP” calls today from VA client and thought it was worth sharing.  Boiled down, this VA buyer was thrown the good old “You were approved” fastball followed by a diving “You are not approved” diving curve ball two weeks before they are slated to close on a home they have under contract.  This specific VA client’s scenario relates to a very inaccurate yet very real technical challenge that is oftentimes overlooked in VA mortgage lending.  I am referring to the fact that the automated underwriting systems that mortgage lenders use (“DU” and “LP”) often misread when a VA borrower discharged a chapter 7 bankruptcy.

Why does this matter?

VA mortgage guidelines require that a VA borrower be 2 years or more beyond the discharge date for a chapter 7 bankruptcy (exceptions to this rule to exist).  What today’s VA client (and many more just like them) is falling victim to is how the automated systems that Arizona VA lenders use read and misread a chapter 7 bankruptcy discharge date.

How DU and LP Read a VA Borrowers Credit Report

The automated underwriting systems that VA loans are submitted through to determine whether or not they are eligible for what is known as an “automated approval” (see below for more) are flawed.  These 2 systems (“DU” and “LP”) pull bankruptcy discharge date data from the “Public Records” section of a VA buyer’s credit report.  The flaw however is that DU and LP also recognize data related to the discharge date of a bankruptcy from within the body of a VA client’s credit report in addition to the “Public Records” section.

This is where things can go a bit sideways if the proper attention to detail is not applied.   Let’s assume an Arizona VA lender is analyzing a credit report for a client who discharged their chapter 7 bankruptcy in 10/2010.   Based on the date I am writing this article (09/02/2013) this particular VA client would have satisfied the 2 year minimum wait requirement relative to Chapter 7 Bankruptcy discharge date.  Sounds great right?  Maybe, maybe not.

The automated underwriting systems used to underwrite an Arizona VA home loan often misread bankruptcy discharge dates.  Here is how.  If a VA borrower has a tradeline on their credit that is tagged as “included in bankruptcy,” DU and/or LP may misread the “last reported” date within that specific tradeline as the discharge date for the bankruptcy rather than the actual discharge date noted in the “Public Records” section.  That is all fine and dandy if the “last reported” date matches the bankruptcy discharge date from the “Public Records” section.  What if the “last reported” date is after the actual bankruptcy discharge date.  This happens more than you would think.  Creditors erroneously continue to report data on a tradeline that was included/paid off in a chapter 7 bankruptcy even after the bankruptcy discharge date.  Sometimes the “last reported” date is dated years after the actual bankruptcy discharge date.  Click on the icon below to see a sample of a tradeline  that shows a delayed “last reported date – this clients actual discharge date was 09/2010:

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 A Misread Bankruptcy Date Can Cause Trouble

The fact that DU and/or LP misreads a bankruptcy discharge date based on the “last reported” date of a tradeline tagged as “included in a bankruptcy” often results in the automated systems requiring a manual VA loan approval.  Why?  If the delayed “last reported” date occurs within the past 2 years DU and LP may think that the VA clients bankruptcy may have been discharged within the past 2 years which violates VA’s minimum 2 year bankruptcy discharge wait period.

The real trouble occurs when a veteran’s loan officer assumes that the borrower meets VA guidelines and assumes they will receive an automated approval due to the fact that the “Public Records” section shows the bankruptcy was discharged at least 2 years ago.  Then, due to the fact that a delayed “last reported” date triggers DU or LP to erroneously think the bankruptcy was discharged within the past 2 years the file will actually need to be manually approved.  So what’s the big difference between a manual approval and an automated approval you ask?  Here are a few key differences that can make or break a Veteran’s ability to qualify for a specific loan amount:

1. Automated approvals allow veterans to go up to a 56.99% debt to income – manual approvals only allow a 45% debt to income ratio
2. Automated approvals allow deferred student loans to be excluded from the borrower’s debt to income – manual approvals do NOT allow deferred student loans to be excluded

There are other differences between automated approvals and manual approvals.  Imagine if a veteran’s Arizona VA mortgage lender makes an assumptive approval based on automated approval guidelines only to find out that the veteran’s VA loan must be manually approved?   Typically a veteran will be approved for a significantly lower VA loan amount based on manual approval guidelines compared to automated approval guidelines.  It is extremely important that a Veteran’s VA mortgage lender is aware of these technical credit related nuances.  It is just as important that your VA mortgage lender runs every VA loan application through the automated underwriting  systems to catch technical snaffoos such as this.

If you have any questions regarding how DU and/or LP can misread a bankruptcy discharge date please contact us today.

By Jeremy House
Google

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