Can You Lose Your House in Bankruptcy?

Filing for bankruptcy raises concerns for homeowners about losing their home. Bankruptcy provides a legal framework to address overwhelming debt and seek a fresh financial start. Retaining a home depends on the type of bankruptcy filed and the homeowner’s financial situation.

Bankruptcy Types and Home Treatment

The treatment of a home in bankruptcy largely depends on the specific chapter filed, primarily Chapter 7 or Chapter 13. Chapter 7 bankruptcy, known as liquidation, aims to discharge most unsecured debts. A bankruptcy trustee is appointed to oversee the debtor’s assets and may sell non-exempt property to repay creditors. A home could be at risk if its equity exceeds the amount protected by applicable exemptions.

If a home contains significant non-exempt equity, the trustee can sell the property to repay creditors. After the sale, the homeowner receives their protected exempt amount, secured lenders are paid, and remaining proceeds go to unsecured creditors. However, if there is no equity beyond the protected amount, or if the home is underwater, the trustee typically will not sell the property.

Conversely, Chapter 13 bankruptcy, often called reorganization, allows individuals with consistent income to keep their assets, including their home. Debtors propose a repayment plan, usually spanning three to five years, to pay back a portion of their debts. This plan requires debtors to maintain ongoing mortgage payments. Chapter 13 can halt foreclosure proceedings and provide a pathway to catch up on missed mortgage payments.

Home Equity and Exemption Protections

Home equity represents the homeowner’s financial stake in their property. It is the difference between the home’s current fair market value and its total outstanding loans and liens. For example, a home valued at $300,000 with a $200,000 mortgage has $100,000 in equity. Equity increases as mortgage principal is paid down or as the property’s market value appreciates.

Bankruptcy exemptions are legal provisions designed to protect a certain amount of property from creditors. The homestead exemption specifically safeguards a portion of a debtor’s equity in their primary residence. The federal homestead exemption allows a debtor to protect up to $31,575 of equity in their principal residence, and this amount can be doubled for married couples filing jointly.

State laws largely govern homestead exemptions, with some states offering very generous or even unlimited protection. In Chapter 7, if a homeowner’s equity falls entirely within the applicable homestead exemption, the trustee cannot sell the home. If the equity exceeds the exemption, the trustee might sell the home, pay the secured creditors and the exempt amount to the homeowner, and use the remainder for unsecured creditors. In Chapter 13, the homestead exemption determines how much non-exempt equity must be accounted for in the repayment plan.

Handling Mortgage Debt in Bankruptcy

A mortgage is considered secured debt, meaning the lender holds a lien on the property as collateral. While bankruptcy can discharge a debtor’s personal obligation to pay the mortgage, the lien generally remains attached to the property. This means that even if the personal debt is discharged, the lender can still enforce their lien through foreclosure if payments are not made.

In a Chapter 7 bankruptcy, homeowners have several options regarding their mortgage debt. One option is to “reaffirm” the mortgage, signing a new agreement to continue personal liability for the debt despite the bankruptcy discharge. This allows the homeowner to keep the property by continuing regular payments, but the debtor remains personally responsible if they default later. Another common approach is to “surrender” the home, voluntarily giving up the property to the lender. Surrendering the property eliminates personal liability for the mortgage debt, including any potential deficiency balance after foreclosure.

For those filing under Chapter 13, the treatment of mortgage debt offers distinct advantages focused on retaining the home. A primary benefit is the ability to “cure arrearages,” allowing debtors to catch up on missed mortgage payments over the three-to-five-year life of the repayment plan. Chapter 13 also provides for “lien stripping,” which can convert a second or junior mortgage into unsecured debt if the home’s value is less than the balance owed on the first mortgage. This junior lien is treated like other unsecured debts in the repayment plan, and upon completion, the lien is removed. Homeowners may also explore loan modification options to alter their mortgage terms.