More than three-quarters of a million people file for bankruptcy each year in the US.
And since bankruptcy can stay on your credit report for up to 10 years, that means there are at least 7.5 million people showing one each time their credit is pulled.
A reader asked this important question:
”I’m trying to prequalify for a home mortgage loan. I filed a Chapter 7 bankruptcy back in 2001. The underwriter wants a letter to explain the bankruptcy, what is the best way to write it? Some say to write hardship due to job loss, but will this help or hurt my circumstance? What exactly are they looking for?”
First, let me say the reader’s question is strange on two counts:
- Chapter 7 bankruptcy automatically is deleted from your credit report 10 years after the filing date. Chapter 13 bankruptcy is deleted seven years after the filing date. A bankruptcy from 2001 shouldn’t even appear on your credit report. If it does, the reader needs to contact the credit bureaus to have it removed.
- The “waiting period” requirement for both conventional and FHA mortgages is just two years. Once two years have passed, you’ll be eligible to apply. However, the mortgage lender can still request a letter of explanation for any derogatory information appearing on your credit report, regardless of the date. But with those two points in mind, let me address the reader’s primary question, which is how to write a bankruptcy explanation letter.
Table of Contents:
Writing a Bankruptcy Explanation Letter
When you write a bankruptcy explanation letter, it must address two critical lender concerns:
#1 The Cause of the Bankruptcy
The bankruptcy was caused by extenuating circumstances. These are hardships that are beyond your control. Examples include a job loss followed by an extended period of unemployment, a business failure, a divorce, a period of disability, or a critical illness of yourself or a family member. There are others, but those are the most common.
The reader should absolutely state his job loss as the reason for the bankruptcy. It will also help to provide any supporting documentation to prove his point.
The worst explanation is that you got too deep in debt, couldn’t pay your bills, and resorted to bankruptcy to get yourself out of trouble. No matter how you see this explanation, the lender will interpret it as your bankruptcy resulting from financial irresponsibility.
#2 The Remedy to Your Problem
The cause of the bankruptcy has been remedied and is behind you. You must make the case that whatever caused your bankruptcy is in the past. If you went through a major medical event, you’ll need to state that you’ve returned to health. If it was due to a failed business, you’ll need to establish that you’ve developed a new, more stable income source.
Both these points will need to be clearly addressed in your bankruptcy explanation letter.
Your Credit Since the Bankruptcy Will Either Support Your Claim – or Deny It
This is another critical point. Even if your bankruptcy explanation letter makes clear that the cause was an extenuating circumstance, and that it’s in your past, the state of your credit since the bankruptcy will provide the proof.
If you filed for bankruptcy in the recent past (or even the distant past), and your credit has been clean since, the lender is much more likely to look upon your application favorably.
But if you have a steady pattern of late payments and collections since the discharge, your credit report will invalidate your bankruptcy explanation letter.
Also, be aware that your overall financial situation will weigh heavily in the lender’s decision.
For example, if your bankruptcy was due to income instability, your income documentation – pay stubs, W-2s, tax returns, etc. – will need to reflect a stable earnings pattern since the bankruptcy.
And one of the best pieces of evidence of recovery from a bankruptcy is a healthy bank account balance. It indicates you’ve mastered the art of living beneath your means, and there’s extra room in your budget to accommodate the new loan payment.
Put another way, while your well-written bankruptcy explanation letter will certainly help your loan application, the substance of your financial profile will be at least as important.
Sample Bankruptcy Explanation Letter
Below is a sample bankruptcy explanation letter, and it’s designed only to be a basic template.
You’ll need to modify it to fit whatever your bankruptcy situation was.
Susan S. Smith
100 Main Street
Mayberry, NC 27998
January 1, 2020
ABC Mortgage Company
200 Elm Street
Mount Pilot, NC 27999
RE: Explanation for 2015 Chapter 7 bankruptcy filing
Dear Ms. Jones:
Please accept this letter as an explanation for my Chapter 7 bankruptcy filing in 2015. Late in 2014, my elderly mother contracted pneumonia. After being hospitalized for more than two weeks, she was confined to bed rest for several weeks more. However, her situation remained precarious for several months.
Enclosed is a copy of my mom’s hospital discharge papers, showing both the diagnosis and the ongoing care requirements.
Since my mom lives alone, and can’t afford a caretaker, I was forced to step into that role. As a result, I was forced to reduce my workload from full-time to part-time, and even missed many workdays in the process. This reduced employment status lasted from December 2014 through June 2015. During that time, my income fell by more than 70%.
Enclosed are copies of my year-to-date paystubs for June 30, 2014 and June 30, 2015. You’ll see that my income through the middle of 2015 was well below the same point in 2014. Even when I returned to full-time work status in the middle of 2015, I continued to miss a substantial amount of time and income in the continued sporadic care of my mom.
I began to fall behind on my bills, and even to rely increasingly on credit cards to pay for basic living expenses. In addition, I personally paid many of my mom’s ongoing care bills, as her financial resources are very limited. I was forced to file Chapter 7 bankruptcy in August, 2015, as I had fallen many thousand dollars in debt that I couldn’t possibly repay.
Mom made a full recovery late in 2015, and has been living independently since. This has enabled me to resume my full-time income. Since the discharge of my bankruptcy, I’ve rebuilt my credit, and even my savings. I ask that you consider my loan application favorably, in light of the extenuating circumstances that led me to filing for bankruptcy.
If more information is required please contact me at (227)555-1234, or by email at [email protected]
Susan S. Smith
Enclosures: Paystubs, medical records
This letter is fairly long, and definitely detailed – both are important. You’ll need to supply as much information as is necessary to state your case.
Providing a summary letter, like one or two brief paragraphs, may not get the job done and may even invite requests for additional information.
Adding Supporting Documentation Will Strengthen Your Case
Notice in the letter above we’ve referenced two pieces of supporting documentation, pay stubs, and medical records. You can make your bankruptcy explanation letter even more credible by including supporting documentation.
For example, if the reason for your bankruptcy was medical, include copies of any records that will substantiate the episode. If it was due to divorce, supply a copy of the divorce decree.
Always realize that the lender isn’t looking for ways to decline your loan application. Instead, he or she is looking for you to supply proof that will justify approving your loan.
Writing a good bankruptcy explanation letter, and providing supporting documentation, will make it easier for the lender to approve your application. Approach it like your approval depends on it – because it just might.