Any number of things can happen in life to shatter a solid financial plan. You might lose your job, get divorced or become very sick. Not everyone who falls hopelessly behind with their bills has control over the situation.
Bankruptcy can be an option, but the possibility is riddled with scary questions like whether you’ll lose your home. Yes, some people do lose their houses when they file, but many others do not. It depends on a several circumstances.
Are You Filing for Chapter 7 or Chapter 13?
The type of bankruptcy you file makes a significant difference. Chapter 13 involves entering into a plan with your creditors to pay off your debts over three to five years. Because you’re paying your debts, there’s no need for the bankruptcy trustee to liquidate your assets and give the money to your creditors, which is what happens in Chapter 7.
Your debts are discharged or erased when you file Chapter 7 – you don't have to pay them – but the bankruptcy court still wants your creditors to receive as much of what you owe them as possible. The trustee assigned to your bankruptcy case is authorized to take possession of your assets – collectively called your bankruptcy estate – and sell them to raise money to satisfy your outstanding debts.
But bankruptcy is intended to give debtors a fresh start, so even filing for Chapter 7 doesn’t automatically mean you’ll lose your home. There are some other factors involved.
How Much Equity Is in Your Home?
The next question becomes how much equity you have in your home. Calculate your equity by subtracting your mortgage balance from your property’s fair market value. If you can afford to have an appraisal done, this will give you a pretty firm idea of what your property is worth. Otherwise, you can ask a realtor for a comparative market analysis. Be sure to include all mortgages or liens against the house.
Don’t just take a guess at what you think your property is worth. If you file for Chapter 7 only to realize that you have more equity in your home than you thought you did, you generally cannot pull the plug and dismiss your bankruptcy proceedings.
If you come up with a negative number when you calculate your equity, you’re in the clear. There’s no logical reason for the trustee to sell the property. The sale would not result in your creditors receiving any money. But what if you have just a little equity? If you owe $250,000 and the house’s value is $255,000 or even $260,000, this still might not be a problem because the trustee would incur costs in selling the property. If those costs would eat up the available equity, there’s no sense in the trustee forcing the sale of your home in this scenario, either.
According to attorney Jen Grondahl Lee, with offices in San Ramon, California, the Chapter 7 trustee is only interested in assets that can be sold to pay creditors.
"If the value of the debtor’s house, minus the cost of selling the house and a possible homestead exemption, is less than the mortgages/liens on the property, the trustee will not be interested in selling the house because there is nothing in it for the creditors,” Lee said.
How Much Is Your Homestead Exemption?
Even if you have some significant equity in your property, you still might not lose it depending on the amount of the homestead exemption that’s available to you. Exemptions are dollar amounts of value in certain assets that the bankruptcy code allows you to keep.
Each state has its own homestead exemptions, and they’re not all the same. Some require that you must use their own exemptions. Others allow you to choose either the state’s exemptions or the federal list – yes, the federal government has one, too. You can use the set of exemptions that’s most advantageous to you, with one caveat. You can’t mix and match them. You can’t use the federal list for one asset and your state’s list for another.
If the amount of your homestead exemption covers all the equity in your home, the trustee can’t sell it. That exemption amount is legally your money. Add the exemption to the total of your mortgage balances and liens against the property. The trustee must be able to sell your home for more than the total, and the same rule applies – if he would only realize a pittance of a profit after factoring in the costs of sale, he probably won’t liquidate your home.
Exemptions can vary wildly, however. If you happen to live in Arizona, the homestead exemption there is $150,000. Some states like Florida and Texas offer unlimited homestead exemptions. But it’s only $5,000 in Kentucky, and New Jersey doesn’t offer a homestead exemption at all – although this is one of those states that lets debtors claim federal exemptions instead. The federal homestead exemption is currently $23,675.
Are You Behind in Your Payments?
There’s one more critical question: Are you current with your mortgage payments?
If your answer is no, filing for Chapter 7 bankruptcy most likely will not help you keep your home, even if any equity is covered by your available homestead exemption. Your mortgage lender is a secured creditor. Your property is secured by the loan against it. Were the trustee to sell it, he would have to satisfy that mortgage out of the proceeds before giving anything left over to your other creditors. But as long as that mortgage is alive and well and in place, it’s a legal instrument which the lender can use to foreclose if you don’t make your mortgage payments. Chapter 7 does not discharge or erase the mortgage lien.
If you find yourself in this situation, you might want to talk to an attorney about filing Chapter 13 instead if possible. You can include your past due balance in your Chapter 13 payment plan. Keep in mind, however, that even if you do this, you must also continue to make your current mortgage payments.
If you’re not behind with your mortgage – or if you’re not so far behind that you can’t catch up before you file for bankruptcy – and if all other factors like equity and your homestead exemption work out in your favor, you can probably save your home. As long as you’re current, your mortgage lender will just keep taking your payments from you regardless of your bankruptcy.