If your home has no equity (meaning the balance of your mortgage or other liens exceeds the value of the house), it is safe in Chapter 7 bankruptcy. This is because the trustee is not interested in selling a property that will not benefit your unsecured creditors. Read on to learn more about how you can keep your home in Chapter 7 bankruptcy if it has no equity.
(Learn more about what happens to your home and mortgage in Chapter 7 bankruptcy here.)
Your Mortgage Lender Retains Its Lien in Chapter 7
Depending on the type of their debt, creditors are classified and treated differently in your Chapter 7 bankruptcy. Your mortgage lender is usually referred to as a secured creditor while most credit card companies are general unsecured creditors. This is because in addition to the note requiring you to pay back the loan, the mortgage company holds a security interest (lien) in your house. This means that if you fail to make mortgage payments or otherwise default on its loan, your mortgage lender can foreclose on the house and sell it to recover its loan. (Learn more about secured debt and how creditors can collect secured debt.)
When you receive a Chapter 7 discharge, only the note (meaning your personal obligation and liability for the mortgage loan) is wiped out. The mortgage lender’s security interest in your house is not eliminated. Even after your discharge, your lender can still foreclose on your house if you stop making mortgage payments. Since the mortgage lien remains on the house, it affects how much your unsecured creditors would benefit if the trustee sold it (discussed below).
Homes With No Equity Have No Benefit to the Bankruptcy Estate
The Chapter 7 trustee’s job is to maximize recovery for your unsecured creditors. However, if the trustee decided to sell your house, he or she would have to pay off the mortgage liens on it prior to distributing any of the proceeds to your unsecured creditors. If you have no equity in the house, there would be no proceeds left to pay unsecured creditors after paying off the mortgage liens.
As a result, if your house has no equity, the Chapter 7 trustee will abandon (not sell) it and you can keep it. However, keep in mind that you still have to continue making mortgage payments. Otherwise your mortgage lender can take the house back through foreclosure.
Example. Sarah owns a house valued at $200,000. Her mortgage balance is $225,000. Since she has no equity in the property, the Chapter 7 trustee will not bother selling it and she can keep her house.