You may be able to keep your home whether you file for Chapter 7 or Chapter 13 bankruptcy. In most cases, Chapter 13 is a better option because it allows you to keep your home regardless of its equity and catch up on your missed mortgage payments. However, whether you should file for Chapter 7 or Chapter 13 bankruptcy depends on the following:
- whether you can exempt all of your home equity
- whether you are behind on your mortgage payments, and
- whether you have junior liens you want to get rid of.
Chapter 13 Is the Better Option If Your Home Has Nonexempt Equity
One of the most important factors to consider when deciding to file for Chapter 7 or Chapter 13 bankruptcy is whether you have equity in your home (meaning your home is worth more than the balance of mortgages or other liens on it). If your home has equity, the next step is to determine if it is exempt. Most states and the federal bankruptcy exemptions have a homestead exemption you can use to protect some or all of the equity in your principal residence. However, homestead exemption amounts vary from state to state. (Find the homestead exemption amount in your state here.)
If the amount of your homestead exemption is not enough to cover all of your equity (assuming no other exemptions apply), then you have nonexempt equity in your home. This means that if you file for Chapter 7 bankruptcy, the trustee will likely take your home, sell it, and distribute the nonexempt portion of the sale proceeds among your creditors. (Learn more in The Homestead Exemption in Bankruptcy.)
However, if you file for Chapter 13, you get to keep your home. This is because in Chapter 13 the trustee does not sell your assets even if they are not exempt. Instead, you must pay your unsecured creditors an amount equal to the value of your nonexempt assets (including your nonexempt home equity) through your repayment plan. (Learn how Chapter 13 bankruptcy works.)
Chapter 13 Is Often Best If You Are Behind on Your Mortgage
Chapter 13 bankruptcy is the better choice again if you have fallen behind on your mortgage. When you file for Chapter 13, you can stop foreclosure and pay off your pre-bankruptcy mortgage arrears (payments you missed) through a repayment plan. A Chapter 13 repayment plan normally lasts three to five years so it provides you plenty of time to cure your default. In addition, you are protected from foreclosure during your Chapter 13 by the automatic stay as long as you continue to make your plan payments and your ongoing mortgage payments as they come due. (You can learn more in Your Home in Chapter 13 Bankruptcy.)
In contrast, if you file for Chapter 7, you do not have the opportunity to catch up on your arrears through a repayment plan. You must get caught up on your own if you want to keep your home. Further, a Chapter 7 bankruptcy typically only lasts a few months so it doesn’t provide you nearly as much protection as Chapter 13. If you don’t cure your default, your mortgage lender can foreclose on your home after the Chapter 7 is closed or even during your case by filing a motion for relief from the stay.
Chapter 13 May Allow You to Get Rid of Junior Liens
If you have a second mortgage (or other junior lien) on your home, Chapter 13 may allow you to get rid of it through a process called "lien stripping." In Chapter 13, you can strip a junior lien if the balance of the senior liens (such as your first mortgage) on your home exceeds the value of the property. When you strip a lien, the junior lienholder gets treated as an unsecured creditor and typically receives little or nothing through your plan. When you complete your plan and obtain a discharge, the lien will be removed from your home. However, lien stripping is not available in Chapter 7 bankruptcy.
When Might Chapter 7 Be Preferable to Chapter 13?
As we discussed, Chapter 13 is usually the better option if you have nonexempt equity, you are behind on your mortgage, or you want to get rid of a junior lien. However, if none of these apply to you, Chapter 7 may be best for you.
A Chapter 7 trustee will not sell your home if you have no equity or you can exempt all of the equity in your home. So if you have no nonexempt equity and you don’t need to catch up on your mortgage or strip a junior lien, Chapter 7 may provide a simpler and quicker way to wipe out your general unsecured debts and still keep your home. (Learn more in Your Home in Chapter 7 Bankruptcy.)