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