If you own an expensive house and file for Chapter 7 bankruptcy, whether you can keep your home depends on whether you have equity in the house, and if you do, whether that equity is exempt.
The Chapter 7 bankruptcy trustee will sell your home if the sale will result in money to repay your creditors. Even if your house is worth a lot of money, the trustee will not sell it if all of your home equity is exempt. Below, we discuss how you may be able to keep your house in Chapter 7 bankruptcy even if it is worth a lot.
Just because your house has a high fair market value doesn’t mean that it is valuable to your bankruptcy estate. When you file for Chapter 7 bankruptcy, liens secured by your house such as mortgages do not get wiped out. Only your personal liability on the loan is eliminated. Your lender can still foreclose on your house if you don’t pay your mortgage.
Since bankruptcy doesn’t get rid of your mortgage lien, the mortgage lender gets paid first if the house is sold. If your mortgage balance is greater than the value of your house (regardless of how much it is worth), there would be no money left over to pay other creditors with after the mortgage is paid off. As a result, the Chapter 7 trustee will not sell your house (even if it is worth a lot) if it has no equity.
Example. Ken and Lily own a house worth $900,000. However, they still owe $950,000 on their mortgage. Since the balance of their mortgage exceeds the value of the house, the trustee will not sell the house if they file for Chapter 7.
How much equity you have in the house matters more than simply what it is worth. As we discussed, since mortgage liens are not eliminated in Chapter 7 bankruptcy, the trustee is only interested in how much value the house has above your mortgage balance.
If your house has equity, you must be able to exempt it if you don’t want the trustee to sell your house. You can use a homestead exemption to protect a certain amount of home equity in your principal residence. The amount of your homestead exemption depends on the laws of your state. Certain states have no homestead exemption. Others allow you to exempt an unlimited amount of equity in your home. (Find the amount of your state's homestead exemption here.)
Example. Heather has an $800,000 house. Her mortgage balance is $700,000 so she has $100,000 of equity in her home. Her state has a $150,000 homestead exemption. Heather can exempt all of her equity with the homestead exemption so the trustee cannot sell her house in Chapter 7 bankruptcy.
Read the articles in Bankruptcy's Homestead Exemption to learn more about how this works.
If you do not fall into either case, then you may want to consider filing a Chapter 13 Bankruptcy.