Whether Chapter 7 bankruptcy makes sense when you own a home depends on your goals -- do you want to save your house, delay foreclosure, or just walk away with less debt?
Most Chapter 7 bankruptcy filers can keep their homes as long as they are current on their mortgage payments. A few lose their home if they have significant equity that can be used by the trustee to pay unsecured creditors. For those planning on walking away from the home, Chapter 7 bankruptcy can delay foreclosure for a short period of time. (To learn about the basics of Chapter 7 bankruptcy, see the articles in Chapter 7 Bankruptcy.)
Losing Your Home in Bankruptcy vs. Losing Your Home in Foreclosure
It is important 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 normal foreclosure process). These are two are separate issues.
If you are behind on your mortgage payments, you will eventually lose your home in foreclosure outside of the bankruptcy process, even though the bankruptcy trustee does not sell your home as part of the bankruptcy.
Will the Bankruptcy Trustee Sell My Home?
You can keep your home in Chapter 7 bankruptcy if you have no equity in the house or you are able to exempt (protect) whatever equity you do have in your home, using the homestead exemption (discussed below). If this is the case, the bankruptcy trustee will not sell your home because there would be no money to distribute to your unsecured creditors. However, most Chapter 7 bankruptcy debtors don't have enough nonexempt equity in their homes to trigger a sale, which means most debtors can keep their homes in bankruptcy.
To determine if the bankruptcy trustee is likely to sell your home, go through this two-step process:
Step One: Determine the Amount of Your Homestead Exemption. The laws of most states allows homeowners to protect a certain amount of the equity in their home from creditors -- this is called the homestead exemption. To figure out the amount of your homestead exemption, you must determine which set of exemptions apply to you. There is a federal homestead exemption (which can be used only in some states), and most states have a homestead exemption amount (usually based on dollar value, but some states limit the amount of acres you can protect from creditors). Which exemption you can use depends on where and when you bought the home, whether the state where you are filing allows use of the federal exemptions, and whether you have moved within the last few years.
For details on how the homestead exemptions work, determining which homestead exemption applies to you, and getting the homestead exemption amounts in your state, see our Homestead Exemption area.
Step Two: Is There Enough Unprotected Equity In Your Home to Trigger a Sale? Next you must determine if you have enough nonexempt equity (equity not protected by the homestead exemption) in your home to trigger a sale in bankruptcy. Start with the market value of your home and subtract the following:
- the amount of homestead exemption you are 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 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 do not have sufficient equity to trigger a sale. This essentially means that the Chapter 7 bankruptcy trustee will have no incentive to sell your home, since there won't be anything leftover to be used to pay the unsecured creditors.
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 may 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.
For more in-depth information, see Nolo's section on Chapter 7 Bankruptcy and Your Home.
Can Chapter 7 Help With Foreclosure?
Chapter 7 might provide some relief from foreclosure, but not by helping you pay off arrears or permanently stopping the foreclosure. To learn more, see Chapter 7 Bankruptcy and Foreclosure.
Here are some other options to consider:
Negotiate with your lender before bankruptcy. If you are behind on mortgage payments, you may 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. (To learn about negotiating with your lender or modifying your loan through new government programs, see Nolo's Foreclosure area.)
Consider Chapter 13 bankruptcy. If you have a mortgage arrearage and want to save your home, consider Chapter 13 bankruptcy, which can allow you to pay off the arrearage through the bankruptcy. (To learn how Chapter 13 bankruptcy affects your home, see Your Home and Mortgage in Chapter 13 Bankruptcy.)