In difficult times when few people have home equity, it's rare to lose a house after filing for bankruptcy. But as the market heats up, and home values rise, the risk that your home will get sold for the benefit of creditors, or that you won't be able to afford to keep it, increases. Two important factors to consider, that could determine the likelihood of you keeping your home, are if you can make your mortgage payments and if you can protect your home equity in bankruptcy. In this article, you'll learn how a bankruptcy filing—and timing—can affect what is probably your most valuable asset.
Most people cannot afford to buy a home outright and must make mortgage payments over time. A mortgage is a secured debt, meaning that if you fail to make the payment, the lender can foreclose on the home, sell it, and use the proceeds to pay down the balance.
The lender's ability to foreclose remains even if you file for bankruptcy. So the first step of keeping your home is being sure that you'll have enough income to continue making your monthly payment.
Also, each bankruptcy chapter offers different benefits, and it's important to select the option that's right for your situation.
Chapter 7 bankruptcy doesn't have a mechanism to help you catch up on missed payments, so you'll want to be current on your mortgage when you file. This chapter works by discharging (forgiving) qualifying debts (such as credit accounts, utility bills, and personal loans) four to six months after filing without requiring you to pay into a payment plan.
By contrast, a Chapter 13 bankruptcy allows you to reorganize your finances over three to five years. This chapter lets you keep a house even if you've fallen behind (as long as you can meet other requirements) because you can catch up by spreading out the arrearages over the three- to five-year repayment period. Another benefit is that you'll be free of debt (except student loans, possibly) by the end of your plan.
Keep in mind that this is only the first step. To prevent losing your house, you must also take into account your equity.
You don't lose everything in bankruptcy. You get to claim some of your property as off-limits to the court and your creditors.
Each state has a list of the assets—and the asset's value—that its residents can hold onto, or "exempt," in a bankruptcy case. For instance, all states let residents protect household goods, furniture, and clothing, and almost all states have exemptions for a vehicle and some equity in your homestead (primary residential property).
If you don't have any equity in your home, you won't have to worry about it being sold in bankruptcy. However, equity problems usually arise when you have more equity than you can exempt—which is the case for many who live in areas experiencing rapid increases in home values. In that case, the risk that you'll have to give up the home will depend on whether you can afford to buy back your nonexempt equity over time.
In a Chapter 7 case, if your house is worth more than you can exempt, the trustee appointed by the court could sell it, return the amount of the exemption to you, and distribute the rest to your creditors. When deciding to sell your house, the trustee has to consider many factors to determine if taking this drastic action is worthwhile. Some considerations are:
To avoid giving up the house, some Chapter 7 debtors (that's what we call those who file bankruptcy) will strike a deal with the trustee to substitute cash or other exempt property for the nonexempt home equity. Other Chapter 7 debtors will elect to file for Chapter 13 instead (more below).
Learn more about the process in Timeline in Chapter 7 bankruptcy.
As a Chapter 13 debtor, you won't surrender any property to the Chapter 13 trustee. Instead, you'll make a monthly payment for three to five years to a trustee who will distribute the money to your creditors.
Your Chapter 13 payment amount will depend on your income, expenses, the amount of your debt, and the value of your nonexempt property, and will have to be enough to cover at least what your unsecured creditors would receive if you filed a Chapter 7 case. (Unsecured debt includes obligations such as credit accounts, medical bills, utility bills, and personal loans.)
For instance, if you have $60,000 in nonexempt home equity that your unsecured creditors would receive in a Chapter 7 case, you'll have to pay at least $60,000 to those same creditors over the course of your three- to five-year repayment plan.
Example. Margaret owns a house worth $150,000. Her mortgage balance is $100,000, leaving her with $50,000 of equity. The exemption in her state will protect $25,000. If she files a Chapter 7 case, the cost to sell the house would be $10,000, and the trustee would realize $15,000 to distribute to unsecured creditors. Instead, Margaret files a Chapter 13 case, so that she won't have to surrender her home. Her monthly plan payments will have to be at least $250 per month so that her unsecured creditors will receive at least $15,000 over five years.
While Chapter 13 bankruptcy can help some debtors save a home, many people must pay additional amounts, too, so the required payment can end up being quite large. It's not uncommon for a debtor to lack sufficient income to make the required repayment plan payment.
For instance, Margaret's Chapter 13 payment will be significantly higher than $250 if she has arrearages that must be included in the plan. Also, she might have other debts that must be paid entirely, like recent income taxes, or past due alimony or child support.
If you'd like to find out more, see Chapter 13 Bankruptcy Timeline.