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 debtors (filers) can keep their homes 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.
You can keep your home in Chapter 7 bankruptcy if you don’t have equity in the house or you’re able to exempt (protect) whatever equity you do have using the homestead exemption (discussed below). If this is the case, the bankruptcy trustee appointed to administer your matter won’t sell your home. There wouldn’t be any money to distribute to your unsecured creditors.
However, as the real estate market recovers, home values can go up quickly. So even though it used to be rare for a Chapter 7 bankruptcy debtor to have enough nonexempt equity in a home to trigger a sale, it’s not necessarily the case now. In fact, many debtors might find that their equity is rising so quickly that it could exceed allowed exemption amounts in a matter of months.
To determine whether 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 allow 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 number of acres you can protect from creditors). Which exemption you can use will depend on where and when you bought the home, whether the state where you are filing allows you to use the federal exemptions, and whether you have moved within the last few years.
Step Two: Is there enough unprotected home equity to trigger a sale? Start with the fair market value of your home and subtract the following:
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.
For more information, see Your Home in Chapter 7 Bankruptcy.
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 are separate processes.
If you’re behind on your mortgage payments, you’ll eventually lose your home in foreclosure outside of the bankruptcy process, even if the bankruptcy trustee doesn’t sell your home as part of the bankruptcy.
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.)