When you sell your home shortly before filing a Chapter 7 bankruptcy, you can only be sure that you can protect the proceeds if your state provides a specific homestead exemption (law) that allows you to do so. In most cases, the better option is to wait to sell the house until after your bankruptcy closes.
In a Chapter 7 case, you must be willing to give up property in exchange for forgiveness of your debt. The court appoints a bankruptcy trustee to sell property and distribute the proceeds to creditors.
You won't be left destitute, however. You can protect assets you'll need for your fresh financial start, such as a modest car, clothing, household furnishings, and, in most states, some equity in your home. Many people can keep everything that they own.
Ultimately, your state decides the type and value of the property you can keep or "exempt." You'll find out what property is exempt by reviewing your state's exemption statutes. Property that isn't protected is called "nonexempt property." Learn more by reading Bankruptcy Exemptions: An Overview.
A homestead exemption protects equity in your home. While almost every state's exemptions include a homestead exemption you can use in bankruptcy, the limits vary widely. Some states allow you to protect only $10,000 or less. In others, you can protect upwards of $500,000, and a few safeguard your entire home. But most fall somewhere in between.
Individuals with a significant amount of home equity can face problems protecting the entire amount and lose their homes if they can't exempt all of it. If a sale will net a profit for creditors, you can expect the Chapter 7 trustee to sell the house. After paying off the mortgage, the trustee will give you the exemption amount and use the remaining sales proceeds to pay other creditors.
If you have that problem and want to keep your home, another solution might be to consider filing for Chapter 13 bankruptcy. You can use Chapter 13 if you meet all requirements, including the ability to pay any nonexempt equity and late payments through the Chapter 13 plan.
If you plan to sell your home shortly before filing a Chapter 7 bankruptcy case, you must ensure a homestead exemption (or other law) specifically states it will cover the proceeds, or that another exemption will protect the funds. Exemptions that protect the proceeds from a sale ordinarily allow six to two years to reinvest the proceeds into another home purchase.
Even if this contingency appears available, consult a local bankruptcy lawyer. The bankruptcy trustee or court could interpret the law differently or disagree with your reinvestment intent, leading to costly litigation.
Suppose you sell your home and put the proceeds in a savings account to purchase another home later. If, after filing for Chapter 7, you discover you can't exempt the funds with a homestead or other exemption, you'd likely lose them.
A specific bankruptcy exemption rarely protects the funds in a bank account, and states with such exemptions often limit them to minimal amounts, such as $500 or less. An alternative would be a wildcard exemption you can apply to deposits. However not all wildcard exemptions can be used for deposit funds or cash, and wildcard amounts vary greatly.
Also, Chapter 7 filers can't dismiss the bankruptcy automatically when something goes wrong, another reason to establish that your money is safe before filing. The bankruptcy court often won't allow the dismissal if continuing would be in the creditors' best interests, which it will be if money is available for distribution.
Anytime you have significant equity to protect, you'll want to meet with a local bankruptcy attorney familiar with the practices of your court. The consultation fee to learn when and how to sell your home safely will be minimal compared to what you could stand to lose and well worth the peace of mind.
Virtually all courts agree that the bankruptcy trustee cannot take the proceeds if you sell the house after the bankruptcy case closes, which is why this is often the best approach. Of course, to keep the house in bankruptcy, you'll need to be able to exempt the equity and satisfy other requirements, such as being current on your mortgage.
If you're lucky enough to reside in a state that allows you to exempt your entire homestead, you might realize enough money from the sale to purchase a new house outright with no financing. However, most debtors won't be so lucky. The amount of money might be enough for a down payment on a new home, but that won't help much if the bankruptcy damages your credit and you cannot get a mortgage.
It usually takes two years after your bankruptcy discharge before you can qualify for an FHA mortgage if you can demonstrate that you suffered a qualifying hardship. You can expect it to take even longer for conventional mortgages.
Because lending guidelines can change, meeting with a mortgage specialist to discuss your case is a good idea. Learn about buying a home after bankruptcy.
Each state's exemption laws vary significantly, and courts have come to different conclusions when they apply exemption laws to home sales proceeds. If you have sold a house and plan to file for bankruptcy or intend to sell soon, a qualified consumer bankruptcy attorney can tell you how a bankruptcy court will likely treat the sales proceeds in your jurisdiction.
Find out about options if you can't afford a bankruptcy lawyer.
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