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Updated on Wednesday, November 21, 2018
Bankruptcy is serious business and should be seen as a path of last resort for those in debt. But once you’ve reached the point of considering this end-of-the-line solution, it’s important to understand the details of how bankruptcy will affect your income and assets.There are two types of bankruptcy for individuals: Chapter 7 and Chapter 13. In either type of bankruptcy, a trustee will investigate your financial situation and make a judgment as to which method of discharging or restructuring the debt will recoup as much of the creditors’ money as possible. A big question in this process is whether the trustee will force the liquidation of assets, and if so, which ones.
Can you file bankruptcy and keep your home?
The disposition of your home in bankruptcy is not a given; it depends on your individual situation and goals, which will dictate which type of bankruptcy you file. Certain types of assets — or portions of certain assets — are exempt from liquidation in bankruptcy, no matter which type you file. Homes often have some amount of exemption.
Each state has its own regulations about which assets are eligible for liquidation and which are exempt. Some states adopt the exemptions that federal bankruptcy laws provide for, while other states have rules of their own on this subject.
The different approaches to assets may allow those filing for bankruptcy to have some say over whether or not they can keep their home.
“The first question out of my mouth is, ‘What do you want to do with your house? Do you want to keep [it] or get rid of it?’” said attorney Shawn Yesner of Yesner Law, who has practiced in real estate and bankruptcy for two decades. His second question is, “Are you current or behind on your mortgage payments?”
These questions matter because of the distinction between Chapter 7 and Chapter 13 bankruptcy.
This type of bankruptcy, also called liquidation bankruptcy, involves a trustee forcing the sale or auction of eligible assets and then using the proceeds of those sales to pay off the creditors. The most advantageous situation for Chapter 7 bankruptcy is one in which everything the debtor owns is exempt, or the eligible assets are only worth a small amount. In the latter case, the trustee won’t try to collect or will collect the requisite amount of cash instead of liquidating assets.
A Chapter 13 bankruptcy is also known as a reorganization because it is more focused on restructuring the debt so the debtor can manage it instead of getting rid of it entirely. In contrast to Chapter 7, which is focused on selling assets, Chapter 13 involves setting up a payment plan that allows the debtor to discharge a portion of the debt, or structure payments over a long period to afford them better.
Chapter 13 is only available to those who have regular income since the payments must be made over time, usually for 60 months.
Understanding homestead exemptions
Whether or not your home is exempt from liquidation in bankruptcy depends on the particular laws in your state. Some states, such as Florida, provide a 100% homestead exemption. In other states, such as New Jersey, a home is not exempt at all. And other states exempt just a percentage of the home’s equity, such as 5% or 75%.
Almost two dozen states allow those in bankruptcy to choose either the state’s exemption level or the federal exemption. The current federal exemption protects $23,675 of equity in a principal place of residence. (That exemption amount will change in April 2019.) Those states that don’t allow the choice of federal exemption require debtors to follow the state’s exemption rules.
There is one instance in which the federal exemption rules may apply in every state. In 2005, the federal Bankruptcy Abuse Prevention and Consumer Protection Act established a minimum ownership period of 1,215 days (about three years and four months) to qualify for a particular level of exemption. If a debtor bought the property within that time frame, they are limited to a homestead exemption of $146,450 for any equity they have in the property. Those who have owned their homes for at least 1,215 days are allowed to use state exemptions that may exclude equity that’s more than $146,450.
What happens to your home in Chapter 7 bankruptcy
Whether or not you can keep your home in Chapter 7 bankruptcy depends on how much money you owe creditors, how much equity you have in your home, what your applicable homestead exemption is and what other eligible assets you own.
Those going through liquidation, the major mechanism for repayment in Chapter 7 bankruptcy, are more likely to be forced to sell their homes than those who qualify for Chapter 13 bankruptcy, which relies more on income-based repayment.
Homestead exemptions can help protect one’s home, but it is important to note that a homestead exemption does not necessarily mean that the home will escape liquidation entirely. It means that the trustee can only pursue the amount of eligible equity that the debtor owns, up to whatever cap applicable state or federal laws impose.
- Example 1: In the case of a $250,000 home with a $100,000 mortgage in Florida, where a homestead is 100% exempt, the trustee will only be able to pursue the homeowners’ equity in the property: $150,000. The trustee can demand that the debtor give him $150,000 by liquidating other assets, or give up the house.
- Example 2: In the case of a $200,000 home with a $100,000 mortgage in Colorado, where the exemption cap is $75,000, the trustee can pursue the difference between the equity and the cap, which is $25,000. The debtor can demand the debtor pay $25,000, or relinquish the home.
- Example 3: In the case of a $150,000 home with a $145,000 mortgage in Kentucky, where the exemption is $5,000, the trustee cannot pursue any repayment based on the asset because the amount of the debtor’s equity is the same or below the exemption amount.
If you are behind on your mortgage payments when you go to file bankruptcy and you want to keep your house, a Chapter 7 bankruptcy is not a possibility. The Chapter 7 process does not include a mechanism to catch up the mortgage over time. Instead, you are required to pay a lump sum to catch up the mortgage. If you have that much money on hand, it’s likely you’re not eligible for Chapter 7 in the first place.If you are behind on your payments and want to get rid of your house, then you can file Chapter 7 or Chapter 13. You’ll want to speak with a bankruptcy lawyer to discern which is preferable based on the value of your assets, your level of disposable income and related factors.
If you are current on your mortgage payments, it is possible to keep your house under Chapter 7 or Chapter 13, depending on which one you qualify for and your level of assets and income.No matter which you file, if you want to keep your house, you should keep the payments current while you’re in the bankruptcy process.
What happens to your home in Chapter 13 bankruptcy
A Chapter 13 bankruptcy will more likely help you keep your home, since the process is not based on selling off assets to discharge all your debts. The creditor will look at your entire financial picture to determine how to best restructure your debts to provide the creditors with the largest possible amount. This brings up scenarios where the trustee pursues debt repayment via disposable income versus asset liquidation.
- Example: Imagine a situation where a debtor owes $18,000 to a creditor and gets on a 60-month payment plan. The debtor’s eligible assets, if sold, would produce $6,000, allowing for a $100 payment each month for 60 months. But the trustee feels that the debtor’s income provides for $300 that can be put toward repayment every month. The trustee determines that the $6,000 in assets are irrelevant since the income can support a $300/month payment that will allow the debt to be paid in 60 months. This person can keep their home.
If the trustee pursues asset liquidation in Chapter 13, the process is subject to the same exemptions that apply in Chapter 7.
If you’re behind on your mortgage payments and you want to save your house, you must file a Chapter 13 bankruptcy. Unlike in Chapter 7, it is possible to catch up the mortgage within the Chapter 13 bankruptcy payment plan. For example, if you are $6,000 behind and you have a 60-month repayment plan, you will pay $100 each month toward catching up the mortgage as part of the repayment.If you are behind in your payments and want to get rid of your house, then you can file Chapter 13 or Chapter 7. You’ll want to speak with a bankruptcy lawyer to see which will be preferable based on the value of your assets, your level of disposable income and related factors.
You can file either Chapter 13 or Chapter 7 if you’re current with your mortgage payments and you would like to keep your house. What you file will depend on which one you qualify for and your level of assets and income. It’s a good idea to keep up with the payments while you’re going through the bankruptcy process.
How to protect your home during the bankruptcy process
Protecting your home during bankruptcy is not always possible; doing so depends on your level of debt and income, the exemptions you qualify for based on state and local laws and the value of your assets that are eligible for liquidation.
Once you’ve filed bankruptcy, you can protect your home by continuing to make on-time mortgage payments. If that’s not possible and you fall behind while your bankruptcy is in process, it’s best to approach the situation strategically.
A Chapter 7 bankruptcy has the advantage of happening in a short time frame — even as quickly as four or five months for straightforward processes that result in a small amount or no money being paid to the trustee.
“Part of the reason I like Chapter 7s is they’re relatively quick,” said Yesner. “If you file a Chapter 7 today and you fall behind three months from now, you’d already be in the discharge process. I’d say wait for the thing to get discharged and then go to the bank and try to start the loan modification process.”
Chapter 13 takes longer and is often more complex, requiring a trip to court to confirm the proposed payment plan. If you fall behind on your mortgage when confirmation has already happened, then you should start the normal loan mediation process outside of the bankruptcy. If you fall behind before the hearing, you may be able to approach the judge to propose a modification of the repayment plan to include the mortgage catch-up payments. It’s best to check with a local bankruptcy attorney if this is your situation.
The laws governing bankruptcy are complex and vary widely by state and even locality. Each court does things slightly differently, so it’s worthwhile to engage a bankruptcy attorney who is familiar with the legal environment in your local area.
Each bankruptcy case will be unique based on not only the location but also on the financial situation and priorities of the filer. The goal of preserving your home is a priority that may dictate a particular course for filing.
“There are so many different variables that go into making a successful bankruptcy,” said Yesner. “If someone says, ‘My brother filed one and it worked great,’ well that doesn’t mean that it will work the same for you.”
Only an experienced bankruptcy attorney will know how to help you navigate this complex terrain.