It’s possible to keep a home when you file for bankruptcy, but the circumstances must be right. You’ll need to be sure that you meet the requirements of the chapter you file. For instance, Chapter 7 filers must be current on payments and protect all home equity with a bankruptcy exemption. By contrast, Chapter 13 filers can catch up on missed mortgage payments and keep the home.
Protecting Your Home Equity in Chapter 7 or Chapter 13 Bankruptcy
Start by determining whether you can protect all of your home equity in bankruptcy. You must complete this critical step in both Chapter 7 and Chapter 13 bankruptcy. In both bankruptcy chapters, you protect an asset with a bankruptcy exemption. Each state has a list of exemptions, so the property type and amount of equity you can protect using state exemptions varies widely. Only a few states let you keep all of your home equity when you file bankruptcy. Most states have a much lower “homestead exemption.” Here’s how the homestead exemption works in Chapter 7 and 13.
• Chapter 7 case: Suppose the exemption isn’t enough to cover the entire amount of your equity. In that case, the Chapter 7 court-appointed trustee will sell it and use the proceeds above your exemption amount to pay off some of your unsecured debt, like credit cards and medical bills.
• Chapter 13 case: Chapter 13 bankruptcy works differently. You won’t be forced to give up any property. Instead, you’ll pay for the nonexempt portion of the equity in your plan. Of course, if you have significant nonexempt equity, this could get expensive. You’ll have to demonstrate that you have enough income to pay all amounts required in your plan.
Keeping Your Home in Chapter 7 Bankruptcy
A Chapter 7 bankruptcy is often more attractive because it’s simpler and gets you on the road to financial stability sooner because you don’t pay into a three- to five-year repayment plan.
You’ll be able to keep your house as long as you meet the following criteria:
• You’re current on your house payments.
• You can protect all of your home equity with a bankruptcy exemption (see above).
• You’ll be able to continue making your payments in the future.
Chapter 7 bankruptcies do have some limits as a tool for managing mortgage debt, however. It won’t help you catch up on past-due payments, and it might be challenging to protect the house if you have a lot of equity in it. The bankruptcy trustee will sell it and use the nonexempt equity to pay other creditors, such as back taxes, credit card balances, and personal loans.
Chapter 13 bankruptcy can be a better choice to address both those issues so you can keep the home. Chapter 13 might also allow you to get rid of second or third mortgages.
Chapter 13 Bankruptcy and Past-Due Mortgage Payments
If you’re behind on your mortgage payments and you want to keep the house, Chapter 13 bankruptcy provides a mechanism for helping you get caught up—something that Chapter 7 bankruptcy cannot do.
• Propose a repayment plan. In Chapter 13 bankruptcy, you propose a repayment plan that will allow you to pay your creditors over three to five years. You can treat your mortgage arrearage as a separate debt and add it to your payment plan.
• Show you have sufficient income. Using the Chapter 13 plan to catch up on your arrearages will only work if you have the income to make both your regular monthly mortgage payment and your plan payment while you’re in bankruptcy.
Once you’re in Chapter 13, the mortgage holder can’t foreclose if you’re paying your house and plan payments on time and keeping to your mortgage terms, like ensuring that you have homeowners’ insurance in place. If you have a second or another junior lien on your homestead, you might be able to get rid of it through a process called “lien stripping.” Lien stripping is available only in a Chapter 13 case and only when your property is worth less than the primary loan balance. To strip the lien, you’ll have to file a motion in the bankruptcy court and present evidence on the property’s value and the mortgage loan balances. If the court voids the junior lien, the debt you owe to that creditor will be treated in the Chapter 13 case as if it were unsecured. Any remaining balance will get wiped out with other qualifying unsecured debt at the end of the case.
Will the Bankruptcy Trustee Sell My Home?
You can keep your home in Chapter 7 bankruptcy if you don’t have any home equity or you’re able to exempt (protect) your equity using the homestead exemption (discussed below). The bankruptcy trustee appointed to administer your matter won’t sell it because, without available equity, there wouldn’t be any money to distribute to your unsecured creditors. But that doesn’t mean you’ll be able to keep the home. You must be current on your monthly payments when you file for bankruptcy (or shortly after that) and must be able to stay current going forward. Otherwise, you’ll risk losing your home through foreclosure. Also, it’s important to realize that as the real estate market recovers, home values can go up quickly. So even though it was rare after the 2008 recession for a Chapter 7 bankruptcy debtor to have enough nonexempt equity in a home to trigger a sale, it’s not necessarily the case in a healthy market. In fact, many debtors might find that in a hot real estate market, home equity rises so quickly that it could exceed allowed exemption amounts in a matter of months.
Here’s a system that will help you determine whether the bankruptcy trustee is likely to sell your home.
Step One: Identify the property.
When you file for bankruptcy, you’re allowed to keep (exempt) the equity in certain types of property. The homestead exemption protects a specified amount of equity in your home or permanent place of residence. You can claim the homestead exemption on one piece of residential property only. In most cases, the property must be your primary residence. However, under some state’s exemption schemes, you can use the homestead exemption to protect a residential trailer or burial plot.
Step Two: Determine the amount of your homestead exemption.
Each state has a system of bankruptcy exemptions that a bankruptcy filer can use to protect property. Most states have a homestead exemption amount based on dollar value, but some states limit the number of acres you can protect from creditors. The amount of your homestead exemption will depend on several factors, including where and when you bought the home, whether the state in which you’re filing allows you to use the federal exemptions, and whether you’ve moved within the last few years.
Here are a few concepts to be aware of:
• State homestead exemption. Each state creates its own set of exemptions residents can use to protect property from creditors—and the homestead exemption varies widely amongst the states. Some allow you to protect as little as a few thousand dollars in equity. In another, you can exempt up to $500,000, or even the entire value of the real property. But most states fall between these extremes.
• Federal homestead exemption. The federal law also has a list of exemptions. You’ll use this list if you can’t claim state residency (it’s rare, but it happens). Also, some states allow you to choose between the state and the federal exemption system but you must select one list exclusively (no mixing exemptions from each list).
• Exemption cap. The bankruptcy code places a limit on the amount of equity you can exempt if you move to another state. This rule prevents people from moving from a state with a small homestead exemption to a state with an unlimited homestead exemption in an attempt to protect more of their assets. However, If you’ve owned a home continuously in the state for at least 40 months, you can exempt the total amount of equity in the property that’s allowed under the exemption. If you sold a home in the state and used the proceeds to purchase another one, the time you owned your old property counts toward the 40 months. If you’ve owned your homestead for fewer than 40 months, you can only exempt a specific dollar amount.
• State residency requirements. Another federal bankruptcy code provision that can affect your homestead exemption is the 730-day rule. To use the state or federal exemptions (if the state allows it) you must live in the state for at least 730 days. Otherwise, you apply the exemptions of the state where you lived for the better part of the 180 days immediately before the 730-day period. In other words, you must go back 910 days, then look forward 180 days. You’ll apply the exemptions of the state you predominately lived in during that 180-day period.
Step Three: Is there enough unprotected home equity to trigger a sale?
Start with the fair market value of your home and subtract the following:
• the homestead exemption amount you’re entitled to claim (usually between $10,000 and $100,000)
• the trustee’s commission on the difference (25% of the first $5,000, 10% of the next $50,000, and 5% of the rest, up to one million)
• the costs of sale (usually around 8% of the fair market value)
• the amount owed on all mortgages, and
• the amount of all nonmortgage liens secured by the home (such as a tax lien).
If you end up with a negative number, you don’t have sufficient equity to trigger a sale, which essentially means that the Chapter 7 bankruptcy trustee won’t have an incentive to sell your home. Since there won’t be anything leftover to be used to pay the unsecured creditors, the trustee will abandon the property. If you end up with a positive number, this is the amount of equity that the bankruptcy trustee could use to pay your unsecured creditors. In this case, the Chapter 7 bankruptcy trustee might sell your home, give you the amount of the homestead exemption, pay off mortgage and lien holders, and use the rest to pay off unsecured creditors.
You’ll want to be able to distinguish between losing your home in bankruptcy (which happens when the bankruptcy trustee sells your home to pay unsecured creditors) and losing your home outside of bankruptcy (that is, through the foreclosure process). These are two separate processes.
If you’re behind on your mortgage payments, you’ll eventually lose your home in foreclosure outside of bankruptcy, even if the bankruptcy trustee doesn’t sell your home.
Can Chapter 7 Bankruptcy Help with Foreclosure?
Chapter 7 bankruptcy might provide temporary relief from foreclosure, but it won’t help you keep the home. It doesn’t have a mechanism to pay off arrears or permanently stop the foreclosure.
Here are some options to consider:
• Negotiate with your lender before bankruptcy. If you are behind on mortgage payments, you might be able to negotiate with the lender to deal with the shortfall, either informally or through a more formal “mortgage workout” where the lender agrees to renegotiate payments terms by modifying the loan or refinancing. If you go this route, complete the loan modification before you file for bankruptcy. Otherwise, the bankruptcy will likely disrupt any ongoing negotiations.
• Consider Chapter 13 bankruptcy. If you’ve fallen behind on your payments but now have enough income to catch up on the mortgage arrearage over time, you can save your home in a Chapter 13 bankruptcy.
How does the bankruptcy trustee sell my home?
In Chapter 7 bankruptcy, your state law determines how much home equity you can exempt (protect) using a bankruptcy exemption. If your home has significant nonexempt equity (equity you can’t protect), the bankruptcy trustee assigned to your case will:
• sell the home
• pay sales costs and any outstanding mortgages (secured debt)
• give you any exemption amount you’re entitled to, and
• use the remaining proceeds to repay unsecured creditors.
Your priority unsecured debts, such as outstanding taxes and support obligations, will be paid first. Any remaining creditors with non priority unsecured claims will receive a pro rata share (percentage) of any funds left after the trustee pays the priority creditors in full. Under most circumstances, the bankruptcy trustee will take the same steps to sell your house as you would. The trustee will list the property for sale with a real estate broker and negotiate a price with a buyer.
The trustee must go through a few additional hoops too, including:
• getting court approval to employ the real estate broker
• obtaining a court order authorizing the sale after finding a buyer, and
• notifying all creditors and interested parties of the home sale so they have the opportunity to object.
The sale could delay the closure of your bankruptcy depending on the real estate market and how long the trustee wants to keep the house listed. For instance, in a down market, it would be unusual for it to take a year or more to sell a vacation home. You’ll still receive your bankruptcy discharge (the order that erases qualifying debt) after three to four months, assuming all proceeds normally. But the bankruptcy case will remain open until the trustee sells the assets or relinquishes them.
Dealing With Chapter 7 Lien Disputes When Selling Your Home
Removing all of the liens from the property and selling it with a clear title can speed up the sales process. A lien lets a lender take the house, sell it at auction, and pay off the mortgage if the purchaser fails to pay the loan. To circumvent the liens, a trustee might get a court order allowing the liens to attach to the sale proceeds. This approach retains the lender’s right to the funds, and if any disputes arise between the various lien holders regarding payment order or the amount, the issues can be sorted out by the court afterward without delaying the sale. If there are no disputes, the trustee pays lien holders and any exemptions you claimed. The remainder is used by the trustee to pay the other creditors in your bankruptcy case.
How to Use Chapter 13 Bankruptcy to Help You
Chapter 13 bankruptcy allows you to set up a repayment plan to pay off the past-due payments, or “arrearage.” You can propose the length of time for repayment, but keep in mind that you’ll need sufficient income to pay BOTH your past-due payments and your current mortgage payments at the same time. So long as you make all of the required payments for the length of the repayment plan, you will avoid foreclosure and be able to stay in your home.
2nd and 3rd mortgage payments: Chapter 13 can also help eliminate payments on second or third mortgages. Typically, Chapter 13 entitles bankruptcy courts to re-categorize second and third mortgages as unsecured debt. Under Chapter 13, unsecured debt takes last priority and usually does not have to be paid back. This re-categorizing process is possible if your first mortgage is secured by the entire value of your home since this means there is no remaining equity in your home to secure the second and third mortgages.
Individuals who are considering drafting a trust or a will may wish to consult with an estate planning lawyer. He or she can explain the advantages of using a trust as well as a will. He or she can make recommendations based on the specific considerations of the client. He or she may even recommend using both documents, such as by using a pour-over will that places any property owned at the time of the testator’s death into the trust.