Should I refinance before or after bankruptcy?

Question: My wife and I have a great deal of credit card and car debt and are considering bankruptcy. We would also like to refinance our mortgage and lower our rate. Unfortunately, even though I think refinancing will help our financial situation, it won't do enough and we want to keep our house. My question is whether I should refinance before or after bankruptcy?

Answer: Whether you should refinance your mortgage before or after filing for bankruptcy will depend on whether you have a better chance of getting approved before and after bankruptcy and whether you plan to file for Chapter 7 or Chapter 13.

For more information on filing considerations, see Should I File for Bankruptcy?

Refinancing Before Bankruptcy

If you are considering filing for bankruptcy relief because you have large amounts of outstanding debt, refinancing your mortgage might not be an option. Each lender has its own guidelines when evaluating your application to refinance. If you have bad credit or a large amount of unsecured debt, you might not qualify.

That said, if you can refinance before filing for bankruptcy, you'd probably be wise to do so, regardless of whether you file for Chapter 7 or Chapter 13. Chapter 13 takes three to five years to complete, and you'd need court approval to move forward with the refinance. Even though Chapter 7 is much shorter, taking approximately four months, unless you have a lot of equity, you'll have a harder time qualifying for a refinance post-bankruptcy.

Also keep in mind that if you refinance your mortgage before bankruptcy and take cash out of your home equity, the bankruptcy trustee will want to know if you still have the money or what you did with it.

If you paid bills shortly before the bankruptcy case, the trustee might be able to use the clawback provision to recapture the funds and redistribute them amongst all creditors according to the rules in bankruptcy law.

If you still have some or all of the money, you'd need to be able to protect it with a bankruptcy exemption—likely the wildcard exemption if your state has one because most states don't provide protection for cash. Simply put, if you decide to refinance your mortgage before bankruptcy, it is best not to take any cash out.

Refinancing After Bankruptcy

Refinancing after filing for bankruptcy can also be difficult. Many conventional lenders require bankruptcy debtors to wait a number of years after filing before applying for a refinance—even though you'll be able to discharge (wipe out) your qualifying debt in a bankruptcy case, making you a better credit risk overall.

Bankruptcy accomplishes this by wiping out most general unsecured debt, such as credit card balances, medical bills, and personal loans (but not student loans in most cases). However, even if bankruptcy improves your monthly budget, lenders still see it as a negative when considering your loan application. Depending on the type of bankruptcy you filed and the type of loan (such as conventional, FHA, or VA) you seek, you may have to wait two to four years after your discharge before you can refinance.

But each lender is different. Just because you filed for bankruptcy doesn't mean that you can't immediately refinance your mortgage afterward. In general, if you find a lender who will refinance your mortgage right after your discharge, you might end up with a higher interest rate or less desirable terms because of your recent bankruptcy. And again, if you are in the middle of a Chapter 13 bankruptcy, you will need to obtain court permission before you can refinance your mortgage.

Get more bankruptcy planning tips.