Can You Go Bankrupt Without Losing Your House?

Bankruptcy is a legal process designed to provide individuals with a fresh financial start by addressing overwhelming debt. For many homeowners, a significant concern when considering bankruptcy is the potential loss of their home. While this is a valid worry, it is often possible to navigate the bankruptcy process without losing your primary residence, depending on various financial factors and the specific type of bankruptcy filed.

Understanding How Your Home’s Equity is Protected

Home equity represents the portion of your home’s value that you truly own, calculated by subtracting outstanding mortgage balances and other liens from its current market value. For example, if a home is valued at $400,000 with a $250,000 mortgage, the equity would be $150,000. This equity plays a central role in how your home is treated in bankruptcy proceedings.

To safeguard this equity, bankruptcy law utilizes “homestead exemptions.” A homestead exemption protects a certain amount of your home’s equity from creditors. These exemptions allow debtors to retain their primary residence and maintain stability.

When filing for bankruptcy, debtors choose between federal homestead exemptions or their state’s exemptions, as they cannot combine them. Some states mandate their own exemptions, while others permit a choice between state and federal options. State exemption amounts vary significantly, with some offering substantial protection, while others provide more limited amounts or no homestead exemption.

Calculating protected equity involves determining your home’s current market value, subtracting secured debts like mortgages, and then applying the homestead exemption. For instance, if your home is worth $350,000, you owe $200,000 on your mortgage, and your state’s homestead exemption is $75,000, your equity is $150,000, but only $75,000 is protected. If a home’s equity exceeds the exemption, that non-exempt portion could be at risk in certain bankruptcy types.

Navigating Chapter 7 and Your Home

Chapter 7 bankruptcy is a liquidation process where non-exempt assets may be sold by a bankruptcy trustee to repay creditors. Most homeowners do not lose their primary residence in Chapter 7, especially if they are current on mortgage payments and their home equity falls within the homestead exemption. The bankruptcy trustee assesses the home’s equity, subtracting the mortgage balance, sale costs (such as a 6% realtor’s fee), and the homestead exemption to determine if there is non-exempt equity for unsecured creditors.

If there is non-exempt equity, the trustee might sell the home, pay off the mortgage, return the exempt amount to the debtor, and distribute proceeds to creditors. This scenario is less common if the home’s value is not substantially higher than the mortgage and exemption. Being current on mortgage payments is important, as lenders can seek to foreclose if payments are not maintained, even after bankruptcy filing.

Homeowners in Chapter 7 have several options regarding their mortgage. One option is a reaffirmation agreement, where the debtor agrees to continue making mortgage payments and remains personally liable for the debt. This agreement must be voluntary, agreed upon by the lender, and approved by the court, often requiring a determination that it does not impose an undue hardship on the debtor. Reaffirming a mortgage can allow for continued credit reporting of on-time payments, but it also means retaining personal liability for a deficiency balance if the home is later foreclosed upon.

Another option is surrender, where the homeowner chooses to give up the property to the lender. This is pursued when the home is unaffordable or “underwater.” By surrendering, the debtor eliminates personal liability for the mortgage debt, including any deficiency balance after foreclosure. When surrendering, the debtor indicates this intent in the bankruptcy filing, and while an automatic stay halts foreclosure, the lender can request court permission to proceed with foreclosure.

Navigating Chapter 13 and Your Home

Chapter 13 bankruptcy provides a structured path for individuals with regular income to repay debts over time. This chapter is particularly helpful for homeowners who are behind on mortgage payments but wish to keep their home. It allows debtors to catch up on missed mortgage payments, known as arrears, through a repayment plan, usually lasting three to five years.

Under a Chapter 13 plan, the debtor proposes a repayment schedule to the court and a bankruptcy trustee. This plan incorporates past-due and ongoing mortgage payments. As long as the debtor adheres to the plan and makes required payments, the lender cannot pursue foreclosure. Failure to make payments as outlined in the plan can lead to dismissal of the bankruptcy case and renewed foreclosure risk.

Even if a home has non-exempt equity, Chapter 13 allows the debtor to keep it. The repayment plan must ensure that unsecured creditors receive at least as much as they would in a Chapter 7 liquidation, by paying the value of non-exempt equity over the plan’s duration. This provides flexibility for homeowners with equity that might be at risk in a Chapter 7 case.

Chapter 13 allows for “lien stripping,” which can eliminate junior mortgages (like second or third mortgages) or home equity lines of credit (HELOCs) if the home’s value is less than the first mortgage balance. If the first mortgage covers the home’s entire market value, junior liens are considered wholly unsecured and reclassified as unsecured debt in the Chapter 13 plan. Once the plan is successfully completed, these stripped liens are discharged, removing personal liability.

Chapter 13 requires the debtor to demonstrate regular income to fund the repayment plan. The plan typically lasts three years if income is below the state median, and five years if above. This ensures the debtor can meet the plan’s financial commitments, including mortgage arrears, ongoing payments, and other debts, providing a pathway to retain homeownership while reorganizing finances.