Your Home in Chapter 7 Bankruptcy

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 a home if they’re current on their mortgage payments and they don’t have much equity. However, it’s likely that a debtor will lose the home in a Chapter 7 bankruptcy if there’s significant equity that the trustee can use to pay creditors. For those planning to walk away, filing can delay foreclosure for a short period.

Will the Bankruptcy Trustee Sell My Home?

You can keep your home in Chapter 7 bankruptcy if you don’t have any home equity or you’re able to exempt (protect) your equity using the homestead exemption (discussed below). The bankruptcy trustee appointed to administer your matter won’t sell it because, without available equity, there wouldn’t be any money to distribute to your unsecured creditors.

But that doesn’t mean you’ll be able to keep the home. You must be current on your monthly payments when you file for bankruptcy (or shortly after that) and must be able to stay current going forward. Otherwise, you’ll risk losing your home through foreclosure (more below).

Also, it’s important to realize that as the real estate market recovers, home values can go up quickly. So even though it was rare after the 2008 recession for a Chapter 7 bankruptcy debtor to have enough nonexempt equity in a home to trigger a sale, it’s not necessarily the case in a healthy market. In fact, many debtors might find that in a hot real estate market, home equity rises so quickly that it could exceed allowed exemption amounts in a matter of months.

Here’s a system that will help you determine whether the bankruptcy trustee is likely to sell your home.

Step One: Identify the property.

When you file for bankruptcy, you’re allowed to keep (exempt) the equity in certain types of property. The homestead exemption protects a specified amount of equity in your home or permanent place of residence.

You can claim the homestead exemption on one piece of residential property only. In most cases, the property must be your primary residence. However, under some state's exemption schemes, you can use the homestead exemption to protect a residential trailer or burial plot.

Step Two: Determine the amount of your homestead exemption.

Each state has a system of bankruptcy exemptions that a bankruptcy filer can use to protect property. Most states have a homestead exemption amount based on dollar value, but some states limit the number of acres you can protect from creditors.

The amount of your homestead exemption will depend on several factors, including where and when you bought the home, whether the state in which you’re filing allows you to use the federal exemptions, and whether you’ve moved within the last few years.

Here are a few concepts to be aware of:

• State homestead exemption. Each state creates its own set of exemptions residents can use to protect property from creditors—and the homestead exemption varies widely amongst the states. Some allow you to protect as little as a few thousand dollars in equity. In another, you can exempt up to $500,000, or even the entire value of the real property. But most states fall between these extremes. You can learn more about exemptions in all 50 states in Bankruptcy Exemptions by State.
• Federal homestead exemption. The federal law also has a list of exemptions. You’ll use this list if you can’t claim state residency (it’s rare, but it happens). Also, some states allow you to choose between the state and the federal exemption system—but you must select one list exclusively (no mixing exemptions from each list).
• Exemption cap. The bankruptcy code places a limit on the amount of equity you can exempt if you move to another state. This rule prevents people from moving from a state with a small homestead exemption to a state with an unlimited homestead exemption in an attempt to protect more of their assets. However, If you’ve owned a home continuously in the state for at least 40 months, you can exempt the total amount of equity in the property that’s allowed under the exemption. If you sold a home in the state and used the proceeds to purchase another one, the time you owned your old property counts toward the 40 months. If you’ve owned your homestead for fewer than 40 months, you can only exempt a specific dollar amount. (You’ll find the current exemption cap in The Homestead Exemption in Bankruptcy.)
• State residency requirements. Another federal bankruptcy code provision that can affect your homestead exemption is the 730-day rule. To use the state or federal exemptions (if the state allows it) you must live in the state for at least 730 days. Otherwise, you apply the exemptions of the state where you lived for the better part of the 180 days immediately before the 730-day period. In other words, you must go back 910 days, then look forward 180 days. You’ll apply the exemptions of the state you predominately lived in during that 180-day period.

Step Three: Is there enough unprotected home equity to trigger a sale?

Start with the fair market value of your home and subtract the following:

• the homestead exemption amount you’re 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 fair 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 don’t have sufficient equity to trigger a sale, which essentially means that the Chapter 7 bankruptcy trustee won’t have an incentive to sell your home. Since there won't be anything leftover to be used to pay the unsecured creditors, the trustee will abandon the property.

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 might 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.

Losing Your Home in Bankruptcy v. Losing Your Home in Foreclosure

You’ll want to be able 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 foreclosure process). These are two separate processes.

If you’re behind on your mortgage payments, you’ll eventually lose your home in foreclosure outside of bankruptcy, even if the bankruptcy trustee doesn’t sell your home.

Can Chapter 7 Bankruptcy Help With Foreclosure?

Chapter 7 bankruptcy might provide temporary relief from foreclosure, but it won’t help you keep the home. It doesn’t have a mechanism to pay off arrears or permanently stop the foreclosure.

Here are some options to consider:

• Negotiate with your lender before bankruptcy. If you are behind on mortgage payments, you might 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. (You’ll find information about lender negotiation and loan modifications in Foreclosure.)
• Consider Chapter 13 bankruptcy. If you’ve fallen behind on your payments but now have enough income to catch up on the mortgage arrearage over time, you can save your home in a Chapter 13 bankruptcy.

(You’ll find more information by reading How Bankruptcy Can Help With Foreclosure.)