Can I File Chapter 7 If I Have Equity in My Home?

Filing for Chapter 7 bankruptcy offers a fresh financial start for individuals struggling with debt. Homeowners often wonder how their home equity might be affected. While home equity does not automatically disqualify someone from Chapter 7, it introduces complexities. Understanding how home equity is treated in the bankruptcy process is important for anyone considering this path.

How Chapter 7 Treats Home Equity

In Chapter 7 bankruptcy, all debtor assets, including home equity, become part of the “bankruptcy estate.” This estate gathers assets potentially used to repay creditors.

A bankruptcy trustee oversees this estate, liquidating non-exempt assets to distribute proceeds among creditors. The trustee’s role is to maximize return to unsecured creditors. A key step involves determining which assets, including home equity, are “exempt” and protected from liquidation, versus “non-exempt” and at risk.

Protecting Home Equity with Exemptions

Exemptions are legal provisions that allow debtors to protect certain property from liquidation by the bankruptcy trustee. These exemptions are fundamental to the bankruptcy system, ensuring individuals are not left without basic necessities after debt discharge. Debtors must choose between federal or state exemptions, as some states require their own.

The homestead exemption protects equity in a primary residence. The protected amount varies significantly by state, ranging from tens to hundreds of thousands of dollars. For example, the federal homestead exemption is around $27,900 for a single filer, doubled for joint filers. Some states, like Texas, offer exemptions that can protect a significant portion of a home’s value, such as $100,000.

Other exemptions, like a “wildcard” exemption, may apply to home equity if the homestead exemption doesn’t cover the full amount. A wildcard exemption is flexible, protecting assets not covered by specific exemptions or supplementing others. For instance, the federal wildcard exemption allows protection of a base amount plus any unused federal homestead exemption, making it a valuable tool. Individuals should research their state’s specific exemption laws or consult a professional.

When Equity Exceeds Exemptions

If a debtor’s home equity surpasses the amount protected by applicable exemptions, the non-exempt portion becomes an asset that the bankruptcy trustee has a legal duty to administer for the benefit of creditors. In such cases, the trustee may decide to sell the home. The trustee will generally only pursue a sale if there is enough non-exempt equity to make the process worthwhile after accounting for sales costs, existing liens, and the debtor’s exempt portion.

Should the home be sold, the debtor would first receive the amount of their protected equity from the sale proceeds. After secured creditors, such as mortgage lenders, are paid, the remaining proceeds would go to the trustee to distribute to unsecured creditors. However, trustees often consider whether the liquidation costs and the amount of non-exempt equity would result in a meaningful distribution to creditors before proceeding with a sale. In certain circumstances, a debtor might be able to negotiate with the trustee to “buy out” the non-exempt equity, thereby allowing them to keep the home and avoid a sale.

Chapter 13 as an Alternative

For individuals with significant non-exempt home equity who wish to keep their home, Chapter 13 bankruptcy presents a viable alternative to Chapter 7. Chapter 13 is often referred to as a “reorganization” or “wage earner’s” bankruptcy because it involves the debtor proposing a repayment plan over a period of three to five years. This structured approach allows debtors to address their financial obligations while retaining their assets.

In a Chapter 13 filing, debtors retain possession of all their assets, including their home, provided they adhere to the terms of their court-approved repayment plan. While the home is not liquidated, the amount of non-exempt equity still plays a role in the repayment plan. Debtors must pay unsecured creditors at least as much as they would have received in a Chapter 7 liquidation, meaning non-exempt equity is paid back over the plan’s life. Chapter 13 offers benefits such as the ability to catch up on mortgage arrears, potentially strip off junior liens in some cases, and avoid the forced sale of the home that could occur in Chapter 7 if there is substantial non-exempt equity.