Having equity in your house won’t prevent you from filing bankruptcy, but you could be in danger of losing the house if you can't protect (exempt) it. What will happen to your equity will depend on the bankruptcy chapter that you file, how long you’ve owned the home, and the state (or federal) exemption scheme that you’ll be entitled to use.
The two bankruptcy chapters—Chapter 7 and 13 bankruptcy—offer different benefits. Both allow you to exempt a certain amount of equity in your home. What will happen to any nonexempt equity—the amount you can’t protect—will depend on the chapter that you file.
In Chapter 7 bankruptcy, the trustee assigned to your case will review your paperwork to determine if you have any nonexempt property. If so, you’ll be required to turn it over so it can be sold to pay off some of your debt. Here’s how it works:
If you’d like to keep a homestead with nonexempt equity, you’ll probably be better off pursuing a Chapter 13 bankruptcy.
Instead of handing over your house or other nonexempt property to a Chapter 7 trustee, you can keep the property in this chapter. It’s not free, however. You’ll pay your creditors the nonexempt amount as part of your three- to five-year monthly payment.
This system works well for everyone involved. Creditors will receive as much as they would have in a Chapter 7 case, and you’ll preserve the equity in the house.
In every bankruptcy case, you’re allowed to claim some property as exempt, meaning that you won’t have to give it up to a bankruptcy trustee who will use it to pay your creditors’ claims. State law defines the types and value of the property you can exempt. Some states give you a choice between the state exemptions or the federal exemption scheme.
Most states allow an exemption for equity in your homestead, meaning your primary residence. If you own other real property, you’ll only be able to exempt the equity in the other properties if there is a specific exemption under state or federal law that would cover it (and there usually isn’t).
To determine which scheme you’re entitled to use and whether you’re subject to an equity cap, you’ll want to ask yourself a few questions.
If you’ve moved to a new state within the last two years, you won’t be able to apply the new state’s exemptions. Instead, you’ll have to use the homestead exemption allowed by the state where you lived for the 180 day period that preceded that two years (called the 730-day rule).
Example. Suppose that you lived in Tennessee from February 1, 2011, to August 15, 2016, and, on August 16, 2016, you moved to Alabama. If you file a bankruptcy case on April 23, 2017, you’d be limited to the Tennessee scheme because after going back 730 days before the moving, you were living in Tennessee during the 180-day period immediately beforehand.
Someone who owns a homestead for less than 40 months before filing for bankruptcy will be subject to a $160,375 exemption cap (this amount will increase in 2019), regardless of the exemption scheme. This limitation was designed to discourage people from moving to take advantage of generous homestead exemptions offered by a handful of states.
(Learn more in The Homestead Exemption in Bankruptcy.)