You don't lose everything when you file for bankruptcy. If you have equity in your residential home—meaning your home is worth more than what you owe the mortgage lender—the homestead exemption can help you protect some or all of your nest egg.
In Chapter 7 bankruptcy, the trustee won't sell your home if the homestead exemption covers all of the equity. In Chapter 13 bankruptcy, you can keep your residence, but you'll have to reimburse your creditors an amount equal to the nonexempt equity—the portion that isn't protected by the exemption—over the course of your repayment plan.
Read on for details about the homestead exemption or see Bankruptcy Exemptions.
Like all of your property, the equity in your home is an asset in bankruptcy. Bankruptcy exemptions, including the homestead exemption, allow you to protect property that you'll need to maintain a household and employment.
Bankruptcy exemption amounts vary by state, so the amount you'll be able to protect will depend on where you live (more below). Also, the bankruptcy chapter you file will determine what will happen to your home if you can't protect all of the equity. Here's how the homestead exemption works in each chapter.
The bankruptcy trustee sells nonexempt property in a Chapter 7 bankruptcy. If your house has nonexempt equity, the bankruptcy trustee will do the following:
By contrast, a Chapter 13 bankruptcy trustee won't sell your property. Instead, you can keep nonexempt property, but at a cost. You must pay an amount equal to the nonexempt portion through your Chapter 13 repayment plan. Making the required payment can be problematic if you have lots of nonexempt equity in your home. If you don't have the income to do so, it's unlikely that the court would approve (confirm) your three- to five-year repayment plan.
Example 1. Let's say your house is worth $500,000 but you still have a mortgage balance of $400,000. This means that your equity (the amount the trustee would net after a sale) in your home is $100,000. If your state has a homestead exemption greater than $100,000, then you'd have nothing to worry about in bankruptcy. In a Chapter 7 case, you could use that exemption to keep the bankruptcy trustee from being able to sell your house to pay your creditors. In a Chapter 13 case, you wouldn't have to pay for any equity in your repayment plan.
Example 2. Assume the same facts except that your state's homestead exemption is only $50,000. In a Chapter 7 bankruptcy, the trustee would sell the house, distribute the money in the manner outlined above, and use the balance to pay unsecured creditors. In a Chapter 13 bankruptcy, you could keep the house, but your unsecured creditors would need to receive at least $50,000 over the course of your three- to five-year repayment plan.
Understanding the Role of the Bankruptcy Trustee
When you file a bankruptcy case, the court appoints an official called a "bankruptcy trustee" to administer it. The trustee reviews the paperwork filed with the court, as well as additional documents—called 521 documents—sent to the trustee shortly after that.
The 521 documents include paycheck stubs, bank statements, income tax returns, and any other items specially required by the trustee assigned to your matter. For instance, it's not uncommon to provide your most recent car loan or mortgage statement, or the marital settlement agreement from your divorce.
Also, all bankruptcy filers must attend at least one court appearance called a 341 meeting of creditors. During the session, you can expect the trustee to do the following:
- place you under oath
- verify your identification and the accuracy of your petition
- inquire about unusual details found in your bankruptcy paperwork
- ask standard questions asked of everyone in attendance, and
- allow creditors present to ask questions about your case.
A Chapter 7 trustee will sell all nonexempt property and distribute the proceeds to your creditors. A Chapter 13 trustee won't sell your property. Instead, the trustee will evaluate the appropriateness of your three- to five-year repayment plan—including whether you're paying for nonexempt property. If it fails to meet requirements, the trustee will file an objection asking the court to reject it and argue the same at the confirmation hearing. If the plan meets required standards, the trustee will support the plan's confirmation. Further, the trustee will distribute the monthly plan payments to creditors.
The homestead exemption is different for each state. A federal exemption system exists under federal law, as well. Your state decides whether you can choose between the state and federal system (you must pick one or the other), or whether you must use the state scheme. Some states allow you an unlimited or a very high homestead exemption amount, but most protect a modest amount of equity, and a few states don't have one at all.
To find the homestead exemption amount in your state (and other exemptions) and to determine whether you can use the federal bankruptcy exemptions, go to Bankruptcy Exemptions by State.
In an attempt to prevent people from shielding their assets by moving to and buying a house in a state with an unlimited homestead exemption, federal law places restrictions on the homestead exemption. In order to take advantage of a state's homestead exemption, you must have purchased your home at least 40 months before the bankruptcy (if you sold your home and bought a new one in that same state with the sale proceeds, then the time you owned your first home will still count toward the 40-month requirement).
If you cannot satisfy this requirement, then federal law caps your homestead exemption at $170,350 regardless of your state exemption amount (as of April 1, 2019, and $160,375 for cases filed between April 1, 2016, and March 31, 2019--the figures adjust every three years). Your homestead exemption is also capped at $170,350 if you have committed bankruptcy fraud or certain other crimes. (28 U.S.C. 522(p),(q).)
Updated: March 14, 2019